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The Endogeneity of Trading Volume in Stock and Bond Returns: An Instrumental Variable Approach

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  • Ehab Yamani
  • David Rakowski

Abstract

This paper investigates the joint determination of trading volume and returns. Our approach follows from the argument that trading activity depends on security returns, thus resulting in a reverse causality from returns to trading activity. Using exogenous instruments for security trading activity, we estimate a system of two‐stage simultaneous equations to better model the return‐volume relationship. Our results confirm that returns and trading volume are determined simultaneously in both stock and corporate bond markets and that conclusions about the direction and significance of causality between volume and returns can be reversed once one corrects for the endogeneity of volume.

Suggested Citation

  • Ehab Yamani & David Rakowski, 2019. "The Endogeneity of Trading Volume in Stock and Bond Returns: An Instrumental Variable Approach," The Financial Review, Eastern Finance Association, vol. 54(2), pages 303-344, May.
    • Handle: RePEc:bla:finrev:v:54:y:2019:i:2:p:303-344
    DOI: 10.1111/fire.12182
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    Cited by:

    1. Czech, Robert & Roberts-Sklar, Matt, 2017. "Investor behaviour and reaching for yield: evidence from the sterling corporate bond market," Bank of England working papers 685, Bank of England.
    2. Cheng Jiang & Kose John & David Larsen, 2021. "R&D investment intensity and jump volatility of stock price," Review of Quantitative Finance and Accounting, Springer, vol. 57(1), pages 235-277, July.
    3. Yamani, Ehab, 2023. "Return–volume nexus in financial markets: A survey of research," Research in International Business and Finance, Elsevier, vol. 65(C).
    4. Agapova, Anna & Kaprielyan, Margarita, 2020. "Stock volatility and trading," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    5. Rakowski, David & Yamani, Ehab, 2021. "Endogeneity in the mutual fund flow–performance relationship: An instrumental variables solution," Journal of Empirical Finance, Elsevier, vol. 64(C), pages 247-271.

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