Return Volatility, Trading Imbalance and the Information Content of Volume

In this paper, we examine the relationship between volume and return volatility using the transaction data. We introduce transaction and volume imbalance measures to capture the information content of trades. These two information measures are shown to have a strong explanatory power for return volatility and contain incremental information about the asset values over and above that conveyed by the size and frequency of trades. Also, return volatility is significantly correlated with the percentage of trading volume taking place at NYSE. This result suggests that NYSE trades are more informative and contribute more to price discovery. There is evidence that price discovery concentrates in more heavily traded stocks, particularly the Dow Jones Stocks. Finally, return volatility is found to be persistent at the intraday level. The persistence level is higher for less frequently traded stocks. Return volatility also exhibits temporal variations. In particular, return volatility is significantly higher in the opening half-hour for less frequently traded stocks. Thus, stocks with different frequencies of trades may follow different volatility processes.