A multiplicative model for volume and volatility

Rob Bauer and Fred Nieuwland

Applied Mathematical Finance, 1995, vol. 2, issue 3, 135-154

Abstract: We first present prima facie evidence for the predictions generated by the mixture of distributions hypothesis, using daily German stock returns and their corresponding daily trading volumes and number of trades. These last two variables are used as proxies for the stochastic rate of information arrival when one wishes to explain GARCH effects by adhering to the mixture of distributions hypothesis. We show that there is no need for these proxies when the stochastic rate of information arrival follows an inverted gamma distribution. Daily trading volume and the daily number of trades, however, empirically provide an explanation for the occurrence of conditional heteroskedasticity of the GARCH form. We estimate several specifications where daily trading volume is included in the conditional variance equation additively and multiplicatively. The new multiplicative specification clearly outperforms the additive specification.

Date: 1995
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DOI: 10.1080/13504869500000008

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