A Three-Stage Model of the Volume-Volatility Relation in the Junk Bond Market during the 2007–2008 Financial Crisis

Abstract

This article examines the joint dynamics of volatility-volume relation in the high-yield (junk) corporate bond market during the 2007-2008 financial crisis. I propose a new empirical model of three-stage equations to better estimate the volatility-volume relation that helps in alleviating econometric problems. My central finding is that different methodologies can easily lead to different inferences about the volatility-volume relation in the junk bond market. More specifically, conclusions about the statistical significance and/or the direction of the association between both variables is dependent on the econometric methodology used. From a practitioner perspective, it is important for professional traders holding positions in fixed income securities in their trading accounts to be aware of their asymmetric time-varying volatility-volume shifting trends. Such knowledge helps traders diversify their positions and manage their portfolios more appropriately.

Keywords: Junk bond; trading volume; asymmetric volatility; endogeneity.

JEL Classification: C24; C26; G12.