Volume and Autocovariances in Short-Horizon Individual Security Returns

Abstract

This article tests for the relations between trading volume and subsequent returns patterns in individual securities' short-horizon returns that are suggested by such articles as Blume, Easley, and O'Hara (1994) and Campbell, Grossman, and Wang (1993). Using a variant of Lehmann's (1990) contrarian trading strategy, we find strong evidence of a relation between trading activity and subsequent autocovariances in weekly returns. Specifically, high-transaction securities experience price reversals, while the returns of low-transactions securities are positively autocovarying. Overall, information on trading activity appears to be an important predictor of the returns of individual securities. IN RECENT YEARS, MANY researchers have presented evidence that shorthorizon returns are predictable. Due to the scarcity of short-horizon economic data, the evidence on predictability in short-horizon returns has largely been based on past returns data. For example, Lo and MacKinlay (1988) find that weekly portfolio returns have large positive autocorrelations; Conrad, Kaul, and Nimalendran (1991) and Lehmann (1990) find significant autocorrelations in the returns of individual securities. The evidence suggests that past prices and returns contain important information for forecasting future returns. Typically, these studies also find that the returns of small firms are more predictable. More recent articles have examined the relation between trading volume and predictable patterns in returns. Blume, Easley, and O'Hara (1994) present a model in which traders can learn valuable information about a security by observing both past price and past volume information. In their model, volume provides data on the quality or precision of information in past price movements; this model suggests that there is a significant relation between lagged volume and the current returns on individual securities. and University of Texas-Dallas for their comments. Any remaining errors are ours alone. Niden acknowledges financial support from the University of Notre Dame Center for Research in Business. 1305 1306The Journal of Finance Traders who include volume measures in their technical analysis perform better in the market than those who do not. Blume, Easley, and O'Hara (1994) also conjecture that the relation between past volume and prices may be more pronounced for smaller, less widely followed firms.Campbell, Grossman, and Wang (1993) also explore the relations between volume and returns by modeling the interactions between liquidity investors and risk-averse expected utility maximizers, who effectively act as "market makers." In their model, market makers must be compensated for offsetting the fluctuating demands of liquidity traders; thus, if liquidity traders sell on average, the price drops to enable the market makers to earn a higher return. Because the variations in the aggregate demand of the liquidity traders also generate large levels of trade, volume information can help distinguish between price movements that are due to public infor...

Is the Mean Return of Hotel Real Estate Stocks Apt to Overreact to Past Performance?

“…This could be illustrated by negative values in the cells crossed by column (R3-R1) and row (V2-V1). This finding is not consistent with previous studies such as Campbell et al (1993) and Conrad et al (1994). For example, Campbell et al claim, "Price changes accompanied by high volume will tend to be reversed; this will be less true of price changes on days with low volume".…”

“…But this result is somewhat weak in the long-term for the hotel portfolio. This evidence provides support for the liquidity hypothesis suggested by Lee and Swaminathan (2000), Campbell et al (1993), and Conrad et al (1994).…”

“…These evidences suggest that the magnitude and persistence of mean stock return can be predicted based on trading volume as stated by Conrad et al (1991) and Conrad et al (1994). "Traders can learn valuable information about stocks by observing both past price and past volume information."…”

“…Campbell et al (1993), Blume et al (1994), and Conrad et al (1994) also report that there is strong evidence of short-term price reversals, particularly for high-transaction securities. Working on the long-horizon data, De Thaler (1985, 1987) find stocks with low longterm past returns tend to outperform winners over the subsequent 3-5 years.…”

Run lengths and liquidity

“…For instance, our theoretical measure and empirics are consistent with the findings of Conrad et al (1994) that high transaction (or high volume) securities evidence greater reversals (lower run lengths). The signed trading volume measure of illiquidity developed by Pastor and Stambaugh (2003) is consistent with the logic that increases in order flow result in shorter runs, as market-makers earn premia from injecting liquidity into the market.…”