This study examines the relations between returns, trade volume and market depth for two futures contracts, namely, Stock Index (SI) futures and Crude Palm Oil (CPO) futures traded at the Kuala Lumpur Option and Financial Futures (KLOFFE), and Commodity and Monetary Exchange (COMMEX), respectively. The effect of volume as well as open interest, proxy of market depth, on volatility and vice versa are also studied. Since both volume and open interest are highly serially correlated, these variables are divided into expected and unexpected components. The results show a positive expected and unexpected volume and market depth on volatility, similar to earlier studies on futures market.
This
study investigates the return volatility, trading volume and market depth relationship
in two Malaysian futures contracts. Previous empirical research has focused only
on the positive, contemporaneous relationship between asset price volatility and
trading volume. The underlying argument for price-volume relationship relies on
the rate of information arrival in the financial market. In general, two famous
competing hypotheses put forward in explaining these phenomena are: (i) the sequential
arrival of new information to the market that move both the trading volume and
price or returns (Copeland, 1976; Simirlock and Starks, 1988) and (ii) the mixture
of distribution hypothesis where information may be considered as mixing variable
(Clark, 1973; and Tauchen and Pitts, 1983). The assumption made by sequential
information arrival hypothesis is that new information is not transmitted to all
traders in a single day. Instead, information reaches one trader at a time and
trading therefore occurs in sequence only after each trader receives the information.
The mixture of distribution hypothesis on the other hand argue that information
dissemination is contemporaneous which implies that price and trading volume change
synchronously in respond to new information.
Studies
as that of De-Long et al. (1990) show that price-volume relationship can
also be explained in the model called noise trading. They argue that the activity
of noise traders is not based on economic fundamentals, and therefore, can lead
to temporary mispricing. The price-volume relationship is also discussed by Gallant
et al., (1992) who demonstrate that the past volatilities have good predictive
powers for forecasting trading volume and vice versa. In other words, asset volatility
and volume may be simultaneously determined. Karpoff (1987) in his comprehensive
survey on the return and trading volume relationship in both spot and futures
markets finds that there is a positive correlation between price variability and
volume. Similarly, Grammantikos and Saunders (1986) in their study on currency
futures contract use correlation and causality tests to examine the relationship
between trading volume and price variability. Consistent with the Mixture of Distributions
Hypothesis (MDH) developed by Harris (1987), they find a significant positive
contemporaneous relationship between price variability and trading volume in most
of the futures contract examined. |
