The relationship between stock return volatility and trading volume: the case of the Philippines

Abstract

This article reconsiders the relationship between stock return volatility and trading volume. Based on the multi-factor stochastic volatility model for stock return, we suggest several specifications for the trading volume. This approach enables the unobservable information arrival to follow the ARMA process. We apply the model to the data of Philippine Stock Exchange Composite Index and find that two factors are adequate to describe the movements of stock return volatility and variance of trading volume. We also find that the weights for the factors of the return and volume models are different from each other. The empirical results show (i) a negative correlation between stock return volatility and variance of trading volume, and (ii) a lack of effect of information arrivals on the level of trading volume. These findings are contrary to the results for the equity markets of advanced countries.

Acknowledgments

The authors would like to acknowledge the Faculty Exchange Program of Soka University and De La Salle University–Manila for their support.

Notes

¹ Selçuk (2005) examines the behaviour of the volatility of daily stock market returns of 10 emerging market economies, including the Philippines, using an asymmetric stochastic volatility model that is estimated with the MCMC method. He finds that such model is able to successfully capture the dynamics of return volatility of such markets.

² Liesenfeld (1998, 2001) de-trended trading volume by the exponential trend and two-sided moving average, respectively. We do not employ such techniques as the time trend is always insignificant when we include the Asian currency crisis dummy.

³ It may be possible to consider an alternative model M5; Compared to M1, the model M5 incorporates additional AR(1) process to explain the dynamics of the trading volume. We do not deal with M5, as it implies that the model needs the additional information in order to describe the movement of the trading volume.