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Abnormal Trading Volume and the Cross-Section of Stock Returns Analysis

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Abnormal Trading Volume and the Cross-Section of Stock Returns” by Deok Hyeon Lee, Min Ki Kim, and Tong Suk Kim explores the influence of trading volume on stock performance and the role of behavioral biases and investors’ attention in that relationship.

The study from KAIST College of Business finds that high trading volume stocks outperform in the short term – up to one week – but subsequently underperform over a longer horizon. The authors attribute this time-varying predictability to abnormal trading activity, which is independent of past volume trends.

The research reveals that abnormal trading activity has a significantly positive return forecasting power for up to five weeks, while expected trading activity exhibits a negative predictive power that lasts for longer horizons. By delving into the role of behavioral biases and investors’ attention as key drivers of abnormal trading activity, the study offers valuable insights into the complex dynamics of stock trading volume and the cross-section of stock returns.

Abstract Of Paper

Stocks with high trading volume outperform otherwise stocks for one week, but subsequently underperform at the longer horizon. We show that such time-varying predictability of trading volume is attributed to abnormal trading activity, which is not explained by past volume. Specifically, we find that the return forecasting power of abnormal trading activity is strongly positive up to five weeks ahead. In contrast, the predictive power of the expected trading activity is negative, and lasts for longer horizons. We further argue that behavioral biases and investors’ attention induces abnormal trading activity, but its price impact is primarily related to behavioral biases. Overall evidence emphasizes the role of behavioral biases and investors’ attention to explain trading volume.

Original paper – Download PDF

Here you can download the PDF and original paper of Abnormal Trading Volume and the Cross-Section of Stock Returns.

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Author

Deok Hyeon Lee
College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Min Ki Kim
College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Tong Suk Kim
College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Conclusion

In conclusion, the study “Abnormal Trading Volume and the Cross-Section of Stock Returns” by Deok Hyeon Lee, Min Ki Kim, and Tong Suk Kim sheds light on the time-varying predictability of stock trading volume and its relationship with stock performance.

The research reveals that abnormal trading activity, distinct from past volume trends, plays a crucial role in the return forecasting power of trading volume. While abnormal trading activity demonstrates a strongly positive influence on returns for up to five weeks, expected trading activity exhibits a more enduring negative predictive power.

The study underscores the importance of understanding the impact of behavioral biases and investors’ attention on abnormal trading activity and its potential consequences on stock prices.

By offering a comprehensive analysis of the factors driving abnormal trading volume and its implications for the cross-section of stock returns, this research provides valuable insights for market participants, academics, and policymakers alike.

Related Reading:

Intraday Market-Wide Ups/Downs and Returns

Losers Win, Winners Lose: Evidence Against Market Efficiency

FAQ

Q1: What is the main finding of the research regarding the relationship between trading volume and stock returns, and how does it vary over time?

The research finds that stocks with high trading volume outperform other stocks in the short term, up to one week, but subsequently underperform over a longer horizon. This time-varying predictability is attributed to abnormal trading activity, which is independent of past volume trends. Abnormal trading activity demonstrates a significantly positive return forecasting power for up to five weeks.

Q2: How does abnormal trading activity differ from expected trading activity, and what are their respective impacts on stock returns?

Abnormal trading activity is distinct from expected trading activity and is not explained by past volume trends. The return forecasting power of abnormal trading activity is strongly positive for up to five weeks. In contrast, expected trading activity has a negative predictive power that lasts for longer horizons. The study suggests that abnormal trading activity has a more immediate impact on stock returns, while expected trading activity has a longer-lasting effect.

Q3: What role do behavioral biases and investors’ attention play in the relationship between abnormal trading activity and stock returns?

The study argues that behavioral biases and investors’ attention are key drivers of abnormal trading activity. The impact of abnormal trading activity on stock returns is primarily related to behavioral biases. This highlights the importance of understanding how psychological factors and market participants’ attention contribute to the dynamics of abnormal trading volume and, consequently, influence the cross-section of stock returns.

You can find many more Research Papers here

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