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Return Volatility and Trading Volume: An Information Flow Interpretation of Stochastic Volatility

Torben G. Andersen
The Journal of Finance
Vol. 51, No. 1 (Mar., 1996), pp. 169-204
Published by: Wiley for the American Finance Association
DOI: 10.2307/2329306
Stable URL: http://www.jstor.org/stable/2329306
Page Count: 36
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Return Volatility and Trading Volume: An Information Flow Interpretation of Stochastic Volatility
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Abstract

The paper develops an empirical return volatility-trading volume model from a microstructure framework in which informational asymmetries and liquidity needs motivate trade in response to information arrivals. The resulting system modifies the so-called "Mixture of Distribution Hypothesis" (MDH). The dynamic features are governed by the information flow, modeled as a stochastic volatility process, and generalize standard ARCH specifications. Specification tests support the modified MDH representation and show that it vastly outperforms the standard MDH. The findings suggest that the model may be useful for analysis of the economic factors behind the observed volatility clustering in returns.

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