Stochastic volatility, liquidity and intraday information flow

Abstract

This article examines the relationship among intradaily information flows, volatility and volume based on the Mixture of Distribution Hypothesis (MDH). We generalize the MDH model to accommodate both informed and uninformed trading effects on return volatility. Using a Fourier filtering technique, we uncover the salient long-run dependence of information flow from high-frequency data with a relative short time span. The positive relationship between volatility and volume is primarily driven by the informed component of trading. We find a negative correlation between uninformed volume and volatility. Uninformed trading seems to add depth and liquidity to the market and therefore reduces volatility.

Notes

¹We select this year to avoid a sequence of important market reforms beginning in 1996. Our sample period is short enough to avoid the problem of nonstationarity and long enough to allow precise estimation of the parameters. Previous studies have employed similar short-span samples for analysing information flow.