When noise trading fades, volatility rises

When noise trading fades, volatility rises We hypothesize and test an inverse relation between liquidity and price volatility derived from microstructure theory. Two important facets of liquidity trading are examined: volume and noisiness. As represented by the expected turnover rate (volume) and realized average commission cost per share (noisiness) of NYSE equity trading, both facets are found negatively associated with the ex post and ex ante return volatilities of the NYSE stock portfolios and the NYSE composite index futures. Furthermore, the inverse association between noisiness and volatility is amplified in times of market crisis. The negative noisiness–volatility relation is also supported by our analysis on the effects of trade size on price volatility. The overall results demonstrate that volatility increases as noise trading declines. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

When noise trading fades, volatility rises

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Publisher
Springer US
Copyright
Copyright © 2015 by Springer Science+Business Media New York
Subject
Finance; Corporate Finance; Accounting/Auditing; Econometrics; Operation Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-015-0508-2
Publisher site
See Article on Publisher Site

Abstract

We hypothesize and test an inverse relation between liquidity and price volatility derived from microstructure theory. Two important facets of liquidity trading are examined: volume and noisiness. As represented by the expected turnover rate (volume) and realized average commission cost per share (noisiness) of NYSE equity trading, both facets are found negatively associated with the ex post and ex ante return volatilities of the NYSE stock portfolios and the NYSE composite index futures. Furthermore, the inverse association between noisiness and volatility is amplified in times of market crisis. The negative noisiness–volatility relation is also supported by our analysis on the effects of trade size on price volatility. The overall results demonstrate that volatility increases as noise trading declines.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Mar 26, 2015

References

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