Trading Volume, Information, and Trading Costs: Empirical Evidence

Abstract

This paper examines the empirical relation among trading volume, informational variables (i.e., precision and differential beliefs), the bid-ask spread components, and price volatility using a structural model that treats the spread components, trading volume, and price volatility as endogenous. Specifically, we investigate the direct and indirect effects of informational precision and differential beliefs on trading volume via a structural model representation in general and examine the theoretical ambiguity issue of George, Kaul, and Nimalendran (1994) in particular. Our empirical results indicate that although liquidity trading dampens the effect of informational precision on trading volume, the net effect of informational precision is positive. Also, while higher differential beliefs lead to greater trading by informed traders, it exerts a commensurate negative impact on liquidity trading. As a result, the net effect of differential beliefs on trading volume is insignificant. This new finding refutes the generally accepted belief in the volume literature that greater differences of opinion induce more trading.

Keywords: Trading volume, Information precision, Differential belief, Bid-ask spreads, Structural model

JEL Classification: G1