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Returns and Volume: Between Information and Liquidity

By Serge Darolles, Gaëlle Le and Fol Gulten Mero

Abstract

This paper develops a model for stock trading which takes into account both information and liquidity shocks. First, we distinguish between two trading strategies, information-based and liquidity-based trading, and suggest that their respective impacts on returns and traded volume should be modelized differently. Second, we focus on the contemporaneous volatility-volume relationship to model impacts of information and liquidity. We relax the hypothesis of absence of liquidity problems and extend the standard mixture of distribution hypothesis (MDH) framework. This paper develops a modified MDH model which takes into account information and liquidity shocks. Third, we show how to use a structural model to exploit the volume-volatility relation in order to decompose the traded volume for a given stock into two components. Thus, we separate information from liquidity impact on the observed daily volume. This allows us to extract an average intra-day liquidity measure using daily data

Topics: hypothesis
Year: 2009
OAI identifier: oai:CiteSeerX.psu:10.1.1.353.1504
Provided by: CiteSeerX
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