We develop a financial market trading model in the tradition of Glosten and Milgrom (1985) that allows us to incorporate non-trivial volume. We observe that in this model price volatility is positively related to the trading volume and to the absolute value of the net order flow, i.e. the order imbalance. Moreover, higher volume leads to higher order imbalances. These findings are consistent with well-established empirical findings. Our model further predicts that higher trader participation and systematic improvements in the quality of traders' information lead to higher volume, larger order imbalances, lower market depth, shorter duration, and higher price volatility.
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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number
tecipa-357.
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Gallant, A Ronald & Rossi, Peter E & Tauchen, George, 1992.
"Stock Prices and Volume,"
Review of Financial Studies,
Oxford University Press for Society for Financial Studies, vol. 5(2), pages 199-242.
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