Stock Market Trading Volume
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Trading volume is an important aspect of the economic interactions in financial markets among various investors. Both volume and prices are driven by underlying economic forces, and thus convey important information about the workings of the market. This chapter focuses on the empirical characteristics of prices and volume in stock markets. The interactions between prices and quantities in an equilibrium yield a rich set of implications for any asset pricing model, when an explicit link between economic fundamentals and the dynamic properties of asset returns and volume are derived.
By exploiting the stock market trading volume lo wang between prices and volume in the dynamic equilibrium model, one can identify and construct the hedging portfolio, which can be used by all investors to hedge against changes in market conditions. This hedging portfolio has considerable forecast power in predicting future returns of the market portfolio and its abilities to explain cross-sectional variation in expected returns is comparable to other popular risk factors such as market betas, the Fama and French SMB factor, and optimal forecast portfolios.
The presence of market frictions, such as transactions costs, can influence the level of trading stock market trading volume lo wang and serve as a bridge between the market microstructure literature and the broader equilibrium asset pricing literature. If price and quantity are the fundamental building blocks of any theory of market interactions, the importance of trading volume in understanding the behavior of financial markets is stock market trading volume lo wang.
However, while many economic models of financial markets stock market trading volume lo wang been developed to explain the behavior of prices — predictability, variability, and information content — far less attention has been devoted to explaining the behavior of trading volume. In this chapter, we hope to expand our understanding of trading volume by developing well-articulated economic models of asset prices and volume and empirically estimating them using recently available daily volume data for individual securities from the University of Chicago's Center for Research in Securities Prices.
Our theoretical contributions include 1 an economic definition of volume that is most consistent with theoretical models of trading activity; 2 the derivation of volume implications of basic portfolio theory; and 3 the development of an intertemporal equilibrium model of asset market in which the trading process is determined endogenously by liquidity needs and risk-sharing motives.
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