The present paper examines the causal relationship between trading volume and stock market returns using daily data of the S&P CNX NIFTY and Sensitivity index (SENSEX) for the period from April 1, 2002 to March 31, 2012. Using descriptive statistics, correlation analysis, unit root tests and Granger causality test, the study shows that in SENSEX, the causality runs both ways, while in the case of S&P CNX NIFTY, causality runs one way. On the basis of the above findings, the participants in the stock markets, i.e., brokers, investors, regulators, policy makers, portfolio managers and academicians, can frame strategies to deal with market volatility.

Capital market plays a very significant role in the development of any nation. In India, more volatility has been observed as compared to many developed markets of the world such as USA, Japan and Singapore. Volatility oscillates the volume of trade in the market which directly impacts the stock price and ultimately affects the stock returns. Further, it affects the financial behavior of the investors in taking investment decision. The investor decides to invest through volatility in the market, i.e., buying or selling the particular stock. Investors should understand the causal relationship between the trading volume and stock returns which may help him to frame different market strategies for gaining returns and avoiding losses. Generally, low volume in the market means the market is illiquid and as a result the fluctuation in the price of stock is less as compared to high volume of trade in the market. All these factors which affect the volume of trade in the market and their prices have been discussed profoundly in the area of different streams of management such as Finance, Economics and Accounting. The major area that affects the volume and returns of particularly stock is stock information. In SENSEX and NIFTY in India, increase in volume generally has a relation of information for particular stock or may be other factors such as FIIs, exchange rate, gold price and influence of other indices such as Nikkie, Dow Jones and Nasdaq. Trading volumes can increase even if investors interpret the information identically but they have different prior expectations. DLF stock price declined by more than 50% in one day on account of information of more debt in the financial statements of the company. Therefore, studying the causal relationship between stock returns and trading volume improves the understanding of the microstructure of the stock market. The basic purpose of this relationship study is to provide protection against movement in future in order to reduce the extent of financial risks.

This paper studies the returns-volume causal relationship from different perspectives like trading volume to stock returns, stock returns to trading volume, previous days volume to current returns, and previous days returns to current volume in different stock markets.

Financial Risk Management Journal, SENSEX, NIFTY, S&P CNX NIFTY, Volume-Returns Relationship, Indian Stock Market.