A three-stage model of the volatility-volume relation in the Junk bond market during the 2007-2008 financial crisis

Abstract

PurposeThe purpose of this paper is to examine the joint dynamics of volatility–volume relation in the high-yield (junk) corporate bond market during the 2007–2008 financial crisis.Design/methodology/approachThe author proposes a new empirical model of three-stage equations to better estimate the volume–volatility relation that helps in alleviating three econometrical problems. In Stage 1, the author estimates the fitted values of trading volume using a censored regression model, to alleviate the truncation problems of using Transaction Reporting and Compliance Engine data. In Stage 2, the author calculates the fitted values of bond return volatility using asymmetric Sign-GARCH model, to control for the asymmetric volatility in return series. In Stage 3, the author uses the fitted values of trading volume from the censored regression model (Stage 1) and the fitted values of return volatility from the GARCH model (Stage 2), to better alleviate the endogeneity problems between both variables.FindingsThe central finding is that conclusions about the statistical significance and the direction of the volume–volatility relationship in the junk bond market are dependent on the econometric methodology used.Originality/valueFrom a practitioner perspective, it is important for professional traders holding positions in fixed income securities in their trading accounts to be aware of their asymmetric time-varying volume–volatility shifting trends. Such knowledge helps traders diversify their positions and manage their portfolios more appropriately.