Trading volume and Arbitrage

Abstract

Decomposing returns into market and stockspecific components is common practice and forms the basis ofpopular asset pricing models. What about volume? Can volumebe decomposed in the same way as returns? Lo and Wang(2000) suggest such a decomposition. Our paper contributes tothis literature in two different ways. First, we provide a modelto explain why volumes deviate from the benchmark. Ourinterpretation is in terms of arbitrage strategies and liquidity.Second, we propose a new efficient screening tool that allowspractitioners to extract specific information from volume timeseries. We provide an empirical illustration of the relevance andthe possible uses of our approach on daily data from the FTSEindex from 2000 to 2002