The Relationship between Stock Market Volatility and Trading Volume: Evidence from South Africa

Abstract

The rate of information flow into the market in generating market volatility has been a much debated issue in the finance research. Moreover, since the rate of information cannot be directly observable and quantifiable, trading volume has been considered to be a good proxy for incorporating such information. The mixture of distribution hypothesis (MDH) and the sequential information hypothesis (SIAH) provide the theoretical justification for the relationship between trading volume and market volatility. This paper revisits the relationship between equity trading volume and returns volatility for the Johannesburg Stock Exchange (JSE) of South Africa using daily data over the period of 6th July 2006 to 31st August 2016. Further, it analyzed an after-crisis period, i.e., 1/04/2008 to 8/31/2016, in order to verify the findings. EGARCH and Granger causality models are employed to analyze the volume-volatility relationship. Also the level of volatility persistence has been compared before and after the inclusion of trading volume in the volatility model as an exogenous variable. The analysis shows that the JSE exhibits volatility asymmetry implying that the return volatility responds more to the bad news than to the good news. The relationship between trading volume and market volatility is found to be positive and contemporaneous supporting the MDH. This study also uncover that the volatility persistence remains high even after the inclusion of trading volume as an explanatory variable in the volatility model. The above set of results also holds for the post-crisis sub-sample. Furthermore, the pairwise Granger causality tests indicate a feedback relationship between volume and volatility only in the case of the sub-sample. But for the full sample, a unidirectional causality between volume and volatility, with trading volume Granger causes market volatility was observed. As it was observed that there is a positive and contemporaneous relationship between volatility, and also that the trading volumes cannot attenuate the level of volatility persistence, findings advise the equity market participants to be cautious in their trading behavior; and through messages to the regulators that risk management practice should be strengthened in order to control for market volatility that associated with increasing trading volume.