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

This 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 autoregressive conditional heteroskedasticity 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. Copyright 1996 by American Finance Association.