The Causality between Stock Index Returns and Volumes in the Asian Equity Markets

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ABSTRACT

This investigation empirically examines the relation between daily rates of return and trading volumes on the stock market indices of six developing markets from Asia over the recent 34-month period ending in October 2005. The evidence of these markets supports the view that rising markets are accompanied by rising volumes and vice versa. The volume-return relation is found to depend on the direction of the market itself. The volume-absolute return relation is found to be significantly positive. The Granger causality tests find the absence of causality running in either direction in four of the six markets. In South Korean market, the evidence of causality running from returns to volume is found while the causality running in the diametrically opposite direction is uncovered in the Taiwanese market.

INTRODUCTION

The relation between security prices and the accompanying trading volume has been studied for almost five decades. One of the earliest published studies on this subject can be traced to Osborne (1959). In a 1987 paper, Karpoff provided an excellent review of the research on the relation between price changes and volume until the mid-1980s. Four crucial factors why the investigations of the said relation are important were outlined by Karpoff. Indeed, the various nuances of the relation between price changes and trading volume have continued to capture the interest of researchers and practitioners alike. One particular group of studies which can be found in the literature has focused on three different aspects of price-volume relation in speculative markets. Two of these can be linked to the well-publicized Wall Street beliefs. The Reilly and Norton investment textbook (2003) for example, notes that, "Therefore the technician looks for a price increase on heavy volume relative to the stocks' normal trading volume as an indication of bullish activity. Conversely, a price decline with heavy volume is bearish." Stickel and Verrecchia (1994) refer to one of the more frequently quoted saying that, "volume is the fuel for stock prices." These and similar commonly mentioned postulates provide motivation for the studies which attempt to evaluate the empirical support for these postulates. However, for the most part, the empirical studies have focused on the developed markets. There are only a handful of published studies of price-volume relation in the developing markets. This fact provides further impetus for the present study.

The objective of this paper is to empirically examine the causal relation between the daily returns on the equity market indices and the accompanying trading volumes in six Asian markets during the most recent 34-month period ending in October 2005. The stock market indices of Hong Kong, Indonesia, Malaysia, Singapore, South Korea, and Taiwan are the focus of this investigation. While all six of these markets are considered to be developing or emerging markets, the Hong Kong market is generally viewed to be the most developed stock market and is often studied along with the developed markets of U.S. and Japan. (Chen, et. al, 2001). The specific goals of this study of six Asian markets are:

1. To ascertain if the rising markets are accompanied by rising volumes and if falling markets are accompanied by falling volumes, and to ascertain if there is evidence of asymmetric relation with respect to positive and negative returns;

2. To ascertain if the evidence supports the notion that it takes trading volume to make the market indices move; and

3. To test for the Granger causality between daily index returns and volumes to ascertain if the causality runs from volume to returns or from returns to volume or in both directions.

In the next section, the relevant literature is briefly reviewed. The data, the definitions, and the methodology adopted in this study are outlined in the following section. The empirical findings of this study are discussed in the fourth section. …