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When noise trading fades, volatility rises

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  • Jinliang Li

    (Tsinghua University)

Abstract

We hypothesize and test an inverse relation between liquidity and price volatility derived from microstructure theory. Two important facets of liquidity trading are examined: volume and noisiness. As represented by the expected turnover rate (volume) and realized average commission cost per share (noisiness) of NYSE equity trading, both facets are found negatively associated with the ex post and ex ante return volatilities of the NYSE stock portfolios and the NYSE composite index futures. Furthermore, the inverse association between noisiness and volatility is amplified in times of market crisis. The negative noisiness–volatility relation is also supported by our analysis on the effects of trade size on price volatility. The overall results demonstrate that volatility increases as noise trading declines.

Suggested Citation

  • Jinliang Li, 2016. "When noise trading fades, volatility rises," Review of Quantitative Finance and Accounting, Springer, vol. 47(3), pages 475-512, October.
  • Handle: RePEc:kap:rqfnac:v:47:y:2016:i:3:d:10.1007_s11156-015-0508-2
    DOI: 10.1007/s11156-015-0508-2
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    More about this item

    Keywords

    Noise trading; Liquidity; Volatility; Volume; Trade size;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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