An information theoretic analysis of stock returns, volatility and trading volumes

Abstract

Information theory is used to examine the dynamic relationships between stock returns, volatility and trading volumes for S&P500 stocks. This provides an alternative approach to traditional Granger causality tests when dealing with nonlinear relationships. The article highlights the dominant role played by trading volumes in all of these relationships – even in the return–volatility relation – and finds evidence of a market level feedback effect from index returns to the return–volatility relation at the stock level. The article also produces a number of stylized facts from an information theoretic perspective.

Keywords:

• return–volume relation
• return–volatility relation
• volume–volatility relation
• information theory

JEL Classification:

• C12
• C14
• G12
• G14

Additional information

Funding

This work was supported by the Engineering and Physical Sciences Research Council.