Abnormal Trading Volume

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Following the ideas behind the efficient market hypothesis stock trading volumes should correlate with stock market returns, yet have no predictive power over future returns. New information enters the market, prices adjust and trading volumes increase. Relaxing the efficiency assumptions, some scholars suggest that abnormal trading volume indicates changes in future returns. They argue for a positive abnormal volume-return relationship based on the following strams of thought:

(1) Abnormal volumes and returns autocorrelation:

(2) Abnormal volumes' capability to increase stock liquidity:

(3) Illegal insider trading (e.g., Epps, 1975; Karpoff, 1985): When insider trading is present, the abnormal trading volume approximately equals the volume generated by insiders' transactions. This information is not only relevant for stock exchange commission to detect possible abuses, but also for the market itself as a proxy for possible future stock's performance. Following this line of reasoning, the predictive power of abnormal volume is limited to positive effects as short selling restrictions limit the exploitation of undisclosed negative information.

Empirical evidence supports the positive relationship proposed. Increased trading volumes regularly precede sequences of positive abnormal returns as well as new information disclosures.

References

Bajo, E. 2005

Epps, T. 1975

Karpoff, J.M. 1985