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RFS Advance Access published online on February 21, 2006
Review of Financial Studies, doi:10.1093/rfs/hhj027
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Article

The Impact of Trades on Daily Volatility

Doron Avramov 1 *, Tarun Chordia 2, and Amit Goyal 3
1 Doron Avramov is from the University of Maryland
2 Tarun Chordia is from the Goizueta Business School, Emory University
3 Amit Goyal is from the Goizueta Business School, Emory University

* To whom correspondence should be addressed.
Doron Avramov, E-mail: davramov{at}rhsmith.umd.edu


  Abstract

This paper proposes a trading-based explanation for the asymmetric effect in daily volatility of individual stock returns. Previous studies propose two major hypotheses for this phenomenon: leverage effect and time varying expected returns. However, leverage has no impact on asymmetric volatility at the daily frequency and, moreover, we observe asymmetric volatility for stocks with no leverage. Also, expected returns may vary with the business cycle, i.e., at a lower than daily frequency. Trading activity of contrarian and herding investors has a robust effect on the relationship between daily volatility and lagged return. Consistent with the predictions of the rational expectations models, the non-informational liquidity driven (herding) trades increase volatility following stock price declines and the informed (contrarian) trades reduce volatility following stock price increases. The results are robust to different measures of volatility and trading activity.


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