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Variations in Trading Volume, Return Volatility, and Trading Costs; Evidence on Recent Price Formation Models

Authors

  • F. DOUGLAS FOSTER,

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    • The Fuqua School of Business, Duke University. Detailed comments by an anonymous referee, Tom Smith, René Stulz (the editor), and Robert Whaley substantially improved the paper. We also want to thank Campbell Harvey, David Hsieh, Nancy Keeshan, Fred Lindahl, Kevin McCardle, Mike Moore, Paul Pfleiderer, Duane Seppi, the seminar participants at the WFA meetings in San Diego, the AFA meetings in New York, and the University of Minnesota for their helpful comments. Support from the Institute for Quantitative Research in Finance and the Futures and Options Research Center at Duke University is greatly appreciated.

  • S. VISWANATHAN

    Search for more papers by this author
    • The Fuqua School of Business, Duke University. Detailed comments by an anonymous referee, Tom Smith, René Stulz (the editor), and Robert Whaley substantially improved the paper. We also want to thank Campbell Harvey, David Hsieh, Nancy Keeshan, Fred Lindahl, Kevin McCardle, Mike Moore, Paul Pfleiderer, Duane Seppi, the seminar participants at the WFA meetings in San Diego, the AFA meetings in New York, and the University of Minnesota for their helpful comments. Support from the Institute for Quantitative Research in Finance and the Futures and Options Research Center at Duke University is greatly appreciated.


ABSTRACT

Patterns in stock market trading volume, trading costs, and return volatility are examined using New York Stock Exchange data from 1988. Intraday test results indicate that, for actively traded firms trading volume, adverse selection costs, and return volatility are higher in the first half-hour of the day. This evidence is inconsistent with the Admati and Pfleiderer (1988) model which predicts that trading costs are low when volume and return volatility are high. Interday test results show that, for actively traded firms, trading volume is low and adverse selection costs are high on Monday, which is consistent with the predictions of the Foster and Viswanathan (1990) model.

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