COMMON FEATURES BETWEEN STOCK RETURNS AND TRADING

VOLUME

Marta Regúlez and Ainhoa Zarraga 

Dpto de Economía Aplicada III
(Econometría y Estadística)
Facultad de Ciencias Económicas y Empresariales
Universidad del País Vasco
Current version: April 1998
Very preliminary

Abstract
The main hypothesis of the mixture of distributions models (MDH) is that there is a
common latent factor, the ow of information to the market, driving both stock returns
and trading volume. Using Spanish data on these series we analyze this hypothesis
testing for the existence of common features such as non normality, skewness, kurtosis,
serial correlation and ARCH/GARCH eects.

* We would like to thank Javier Gardeazabal and Gonzalo Rubio for their helpful comments. This work
was supported by Dirección General de Enseñanza Superior del Ministerio Español de Educación y Cultura
and Universidad del País Vasco (UPV/EHU) under research grants PB95-0346 and UPV 035.321-HB067/96.
1 Introduction
Clark (1973) introduced the mixture of distributions model (MDH) devoted to modelling
the distribution of stock price changes. In this approach, the variance of daily price changes
is directed by the random number of daily price relevant information, which serves as the
mixing variable. Using trading volume as a proxy for the latent number of information,
Clark (1973) found that this variable contains signicant explanatory power with regard to
the price change variance. But this inference is based on the assumption that trading volume
is weakly exogenous, which is not adequate if price changes and trading volume are jointly
determined. Tauchen and Pitts (1983) rened Clark's univariate mixture specication by
including trading volume as an endogenous variable and proposed a bivariate mixture model
in which the price change variance and the trading volume are simultaneously directed by the
information arrival process as the common mixing variable. However, Clark (1973) as well
as Tauchen and Pitts (1983) assumed that the information process is serially independent
which cannot account for the well documented autoregressive behavior of the price change
variance. Lamoureux and Lastrapes (1990) analyzed whether an autocorrelated number of
daily information can be regarded as the source of the autocorrelation in the process of price
change variance. They found that the persistence in the variance process disappears after
controlling for the information arrival rate approximated by trading volume. Nonetheless,
this analysis suers from a possible simultaneity bias, induced by treating trading volume as
an exogenous variable. Later on, Lamoureux and Lastrapes (1994) use the mixture model of
Tauchen and Pitts (1983) generalizing their assumption that the information arrival process
is serially uncorrelated. The primary restriction of the model is that information arrival is a

1
common factor aecting both daily returns and volume. The maintained null hypothesis is
that the dynamics of daily return variance are due solely to daily persistence in the latent
speed of arrival of information to the market, which leads to similar dynamics in the level
of trading volume. Their approach indicates that accounting for serial dependence in the
information arrival process does not eliminate GARCH (Generalized Autoregressive Condi-
tional Heteroscedasticity) persistence in variance. More recently, Andersen (1996) develops
an empirical return volatility-trading volume model from a microstructure framework in
which informational asymmetries and liquidity needs motivate trade in response to informa-
tion arrivals. The resulting system modies the so-called MDH. The dynamic features are
governed by the information ow, modelled as a stochastic volatility process and GARCH
specications.
These dynamic specications of a bivariate mixture system provide structural models for
the co-movements of price change variance and trading volume in which the dynamics of both
series are directed by the time series behavior of the common mixing variable. Therefore,
it arises the following interesting question. If the information arrival is a common factor
aecting both daily returns and volume there should be features present in both series that
are shared in common. More specically, following Engle and Kozicki (1993) a feature (serial
correlation, trends and seasonality, heteroscedasticity, skewness, kurtosis, etc.) will be said
to be common if a linear combination of the series fails to have the feature.
In this article we use daily returns and volume data for the Spanish stock market to
analyze whether some features to be detected in stock returns (or stock returns volatility)
and trading volume are actually shared in common. This will be a way of testing the main

2
hypotheses of the bivariate mixture modelling, that is, they are driven by a common factor,
the ow of information to the market. The remainder of the paper is organized as follows.
Section 2 describes the testing procedure of common features. Section 3 describes the data
used. Section 4 reports the results of testing for common features and section 5 summarizes
the results and contains the conclusions.

2 Testing for common features

The statistical model that motivates testing for common features is the unobserved compo-
nents model. Two economic time series, y t and y t might be generated by the model
1 2

0 1 0 1 0 1
BB y t CC BB  CC BtC
B@ CA = B@ CA Wt + BB@ CCA
1 1
(1)
yt 2 1 t 2

where Wt is the latent common factor that presents the feature but the vector t does not. In
this case even though individually y t and y t will present the feature the linear combination
1 2

y t y t will not.
1 2

In our case, the common latent factor Wt will be the ow of information to the market
that aects the dynamics of both returns and volume. So if this is true, those variables
should present common features.
Engle and Kozicki (1993) introduce a class of statistical tests for the hypothesis that some
feature that is present in each of several variables is common to them. Features are data
properties such as serial correlation, trends, seasonality, heteroscedasticity, autoregressive
conditional heteroscedasticity, and excess kurtosis. To detect a feature a test is required and
we suppose that one can be found with standard properties.
3
 Let s(y) be the test statistic, where y represents a data series yt; t = 1; :::; T , and dene
the set of probability measures under consideration for each of the hypothesis H : no feature, 0

H : feature. For s and a particular choice of size as 0.05, the statistic must have the property
1

that there is a critical region fs(y) > cg where c is dened by PH0 [s(y) > c]  0:05. We
reject the null hypothesis of no feature or nd a feature if s(y) > c.
To determine whether a feature is common, a simple procedure can be applied. The null
hypothesis is that the feature is common and the alternative is that it is not. The test is
developed by applying the feature test to the variable u = y 1 y for various values of .
2

As Engle and Kozicki (1993) point out, the distribution of the minimand of s(u) over 
satises:
s(^u)  s(y 1 ^y )  min
2

s(y 1 y )  s(y
2 1 y ) = s(
2 1  )
2 (2)

and then:
PH0 [s(^u) > c]  P [s( 1  ) > c]  5%
2 (3)

The test is applied to the minimized value of the statistic, s(^u), knowing that the null will
be rejected less than or equal to 5% of the time when it is true. Although the test can be
inecient, they show that it is consistent. For many interesting feature specications the
asymptotic distribution of the minimand of s(u) over  can be determined more precisely.
Some of the features we are going to test can be dened in terms of regression hypotheses.
Engle and Kozicki (1993) call them regression-based tests for common features. Suppose that
two series y , y are each tested for a feature in the model,
1 2

y t = xt + zt +  t
1 1 1 1 (4)
y t = xt + zt +  t;
2 2 2 2

4
where in our case y could be daily stock return series and y daily volume. {x,z} are
1 2

assumed to be the same for both series. In the serial correlation case , {x} would be simply
a constant and possibly relevant trends and {z} would include lags of the dependent variable
and possibly other variables. To test whether correlation is common to these data series,
one has to test whether there exists a  such that the linear combination u = y 1 y does
2

not have the feature.

Engle and Kozicki (1993) show that in order to minimize s(u) with respect to  to get

s(^u) = min

s(y 1 y ) = u^0Mxz(z0Mx z) z0Mxu^=^u ;
2
1 2
(5)

where Mx = I x(x0x) x0, u^t = y t y t and ^u is a consistent estimate of the residual
1
1 2
2

variance, iterative or nonlinear procedures are required since  appears in both the numerator
and denominator of s(^u). However, an asymptotically equivalent estimator can be derived
by minimizing the numerator of ( 5). The solution is given by:
h i
^n = y0 Mxz(z0Mxz) z0Mxy y0 Mx z(z0Mxz) z0Mxy ; (6)
1
1 1
2 2 2 1

which is the two-stage least squares (2SLS) estimate of  in the model:

y t = y t + xt + t;
1 2 (7)

where the instrument list is {x,z}. The test statitistic can then be computed as TR of the 2

regression of e, the 2SLS residuals, on the instruments {x,z}. The asymptotic distribution
of the statistic under the null of a common feature is a chi-squared with degrees of freedom
the number of overidentifying restrictions.

5
3 Data
The data used in this work come from 100 nancial stocks of the Spanish continuous stock
market. They are daily data corresponding to the logarithm of stock price (Pt) and of volume
(Vt), the former being the closing price and the latter the number of stocks traded daily. The
sample period considered goes from 19-04-1990 to 29-01-1996, which means a total of 1453
observations of price and volume for each stock. The stock returns series has also been
calculated from the initial price series including corrections for dividends and subscription
rights in the following way:

Rt = ln(Pt + DIt + SUt) ln(Pt );1 (8)

where Rt is the return corresponding to day t, DIt are the dividends corresponding to the
same day and SUt the subscription rights also for day t.
However, not all the nancial stocks are present in the market for the whole sample
period since some of them were incorporated in the market after 19-04-1990, they stopped
trading in the market before 29-01-1996 or even disappeared temporarily from the market
to be incorporated again after a period of time. In this paper it has been considered that,
when a stock has zero volume for more than ve consecutive days, it means that the stock
has stopped being traded in the market for that period, after which it has entered again or
has left the nancial market denitely and, therefore, there are not data for those stocks
during those days. On the other hand, as we use daily data there might exist asynchronous
trading, which means that transactions of the stocks can occur at dierent moments of the
day or simply that not all stocks are traded every day. Hence, it has been considered that
those stocks with zero volume for ve or less consecutive days are aected by these kind of
6
market frictions and, therefore, observations of volume corresponding to those days will be
included in the sample as zeros. In this case, the corresponding price observations will be
those of the last day in which there has been trade.
Even though we have data for individual stocks, as a rst approach we have considered
average daily stock returns and trading volume series using each daily observation of those
stocks with data in that day. These series are stationary but present daily and monthly
calendar eects, which are removed using the two-step procedure of Gallant, Rossi and
Tauchen (1992), which is explained in what follows.
In a rst step, using Ordinary Least Squares (OLS) we estimate the so-called Mean
Equation, which, for the return case, is of the form:

Rt =  + DtR + t; (9)

where  is a constant term and Dt denotes the vector of dummy variables for the dier-
ent days of the week (from Tuesday to Friday) and months of the year (from February to
December).
Then, in a second step we use OLS to estimate the Variance Equation:

ln(^t ) =  + Dt R + t;
2
(10)

where  is a constant term. This second step is used to standardize the residuals from the
mean equation obtaining the following adjusted return series:
!

^t
rt = a + b exp(D ^ =2) (11)
t R

a and b parameters are chosen so that the sample means and variances of rt and Rt are
the same. This linear transformation carried out by Gallant, Rossi and Tauchen (1992)
7
makes the units of measurement of initial and adjusted series the same, thus facilitating the
interpretation of later empirical results. The transformation for the volume series is carried
out likewise obtaining the adjusted series vt.
The data series used for the empirical analysis are the adjusted stock returns and volume
series, whose graphs are depicted in Figures 1 and 2, respectively.

4 Empirical results
As we pointed out in the introduction if both trading volume and stock returns are explained
by a mixing variable, namely the ow of information, it could be thought that features,
understood as data properties, present in the mixing variable are transmitted to volume and
stock returns or a transformation of them so that each series has those features. So, following
Engle and Kozicki (1993), there should be a nonzero linear combination of the series that
does not present the feature. If this is the case, the feature will be common to those series,
because it comes from a common factor.
There are two implicit steps in the procedure to test for common features. The rst is
to determine that the feature is in fact present in each of the original series. If the feature
is only present in one of the original series, then the test proposed for a common feature
will always suggest that there is a common feature because a linear combination that puts
all weight on the series that does not contain the feature will trivially not show evidence of
the feature. Once the presence of a feature is statistically detected in both series, we will
proceed to test the null hypothesis of a common feature. Although, for some cases we will
be able to carry out the test in a regression-based setting and we will have an asymptotic
8
distribution for the statistic to test the null of common feature, for others we will have to
rely on ( 2) and ( 3).
As it has been shown in previous nancial literature, although there is evidence for
some dependence in the conditional mean of asset returns, there is substantially more struc-
ture in the second and higher moments. A short list of documented features includes,
ARCH/GARCH (Bollerslev, Chou, and Kroner (1992)), leptokurtosis (Clark (1973); Gallant,
Hsieh and Tauchen (1991)), various asymmetries (Nelson (1991); Campbell, Grossman and
Wang (1993); Lebaron (1992a,b)), and volume-volatility relations (Tauchen and Pitts (1983);
Karpo (1987); Gallant, Rossi and Tauchen (1992); Lamoureux and Lastrapes (1994)).
For the Spanish case, Zarraga (1998) has found a unidirectional linear causal relation from
stock returns to volume using data aggregated into portfolios, while there is no evidence of
nonlinear causality in the study of the dynamic relation between the variables.
Taking into account these ndings, in a rst approach we have tested for non normality,
serial correlation and ARCH as common features in daily volume and stock return series.
Non normality test is carried out using the statistic proposed by Jarque and Bera (1980).
Under the null hypothesis of normality for a series y the test statistic, JB (y), has the
following asymptotic distribution:
" #
b (
JB (y) = T 6 + 24b1 3)
2
2
a X ; 2
(12)
(2)

p
where b = m33 , b = m44 , mr = T PTi (yi y)r and  = m is the variance of the series,
1 2
1 2 =1 2

being T the sample size.

The results of the tests show evidence of non normality in each series. For return series,
JB (y ) = 1944:423 with a signicance level of 0.000, whereas for volume series, the JB
1

9
statistic is JB (y ) = 27979:903 with a signicance level of 0.000. Clearly, the null hypothesis
2

of normality is rejected for each series.

In order to test whether non normality is common to the series, we have to use an
optimizacion procedure which gives us the value of  such that the JB (u) statistic for the
linear combination u = y 1 y is minimized, where y and y are return and volume series,
2 1 2

respectively. Using a grid search method, the selected value of  is -0.01065, for which the
test statistic JB (u) takes the value 780.661 with a p-value of 0.000. This means that the
linear combination u = y y does not present normality and therefore, the null hypothesis
1 2

of common feature is rejected knowing that at least the type I error is not greater than 5%.
The JB statistic for normality compares a distribution to the normal distribution by
comparing its skewness to zero and its kurtosis to three. The rejection of normality how-
ever, does not inform us of whether the distribution presents skewness, kurtosis or both.
More concrete results can be obtained by testing for skewness and kurtosis. We report the
results of these tests based on the statistics SK for skewness test and KU for kurtosis test,
whose asymptotic distribution under the null hypothesis of no skewness and no kurtosis,
respectively, are the following
" !  # s
SK (y) = (T 1)(T 2) m
T (T 1)(T 2) a N (0; 1)
2


3

6T
3
(13)

and
" ! !#
KU (y) = T 2
(T + 1)m 4
: 3(T 1)m 2
2
(T 1)(T 2)(T 3)  4
v
u
u
t (T 1)(T 2)(T 3) a N (0; 1)
24T (T + 1) (14)

Application of the tests to the data series gives evidence of skewness and kurtosis for
10
each return and volume series, which means that they do not follow a normal distribution,
as proved with the statistic of Jarque and Bera (1980). For the return series the statistics
values are SK (y ) = 5:84594 and KU (y ) = 43:78385, while SK (y ) = 47:32824 and
1 1 2

KU (y ) = 160:63518 for the volume series, with a signicance level of 0:000 for all cases.
2

These values clearly reject the null hypotheses of no skewness and no kurtosis, respectively.
As both data series present skewness and kurtosis, we study the possibility that some or
both features are common to them. We use a search method to nd the value of  in the
linear combination u = y 1 y such that SK (u) and KU (u) statistics are minimized.
2

For the skewness test, the selected value of  is 0:0071 for which the test statistic takes
the value SK (u) = 1:27958 with a p-value of 0:200. Therefore, for a 5% signicance level
the null hypothesis of common feature cannot be rejected, indicating that skewness is a
feature common to stock returns and trading volume series.
On the contrary, we cannot nd a  for the linear combination u = y 1 y such that
2

the value of the KU statistic does not reject the null hypothesis of common feature. In fact,
the value of  that minimizes the KU statistic is  = 0:0109, for which KU (u) = 27:88489,
which shows that kurtosis is not common to data series.
Next, we analyze whether stock returns and volume have common serial correlation.
That is, do lagged returns and volume actually provide information useful for forecasting
both returns and volume in a bivariate system? Under the null hypothesis of "no feature"
returns and volume are orthogonal to the information set including lagged stock returns and
volume. This orthogonality condition can be tested estimating by least squares each equation
of ( 4) and using the statistic TR of the estimated regressions, which asymptotically follows
2

11
a chi-squared distribution with degrees of freedom the number of overidentifying restrictions.
In our case, equations ( 4) form a bivariate V AR(20) model, where the order, p, has been
selected not only according to the Final Prediction Error, FPE (p), Akaike's Information,
AIC (p), Hannan-Quinn, HQ(p), and Schwarz, SC (p), criteria but also imposing that the
corresponding residuals are white noise . The results of serial correlation tests applied to
1

each of the data series show evidence that both return and volume series present this feature
since the statistics values are TR = 70:567 with a signicance level of 0:002 for return series
2

and TR = 369:095 with a signicance level of 0:000 for volume series. Each of the statistics
2

follows asymptotically a chi-squared distribution with 40 degrees of freedom.

Given that we have rejected the null of no serial correlation for both series, we posit the
question of common feature: do the series share the dynamics in common? To test such a
common feature we follow the regression-based test explained in section 2. The list of instru-
ments used for the 2SLS estimation is fconstant; y ;t ; y ;t ; : : :; y ;t ; y ;t ; y ;t ; : : :;
1 1 1 2 1 20 2 1 2 2

y ;t g. In this case, the statistic TR follows asymptotically a chi-squared distribution

2 20
2

with 39 degrees of freedom and takes the value TR = 68:781 with a signicance level of
2

0:002, which indicates that the null hypothesis is rejected suggesting that the movements in
stock returns and volume are not driven by a common factor.
The next feature we focus on is autoregressive conditional heteroscedasticity (ARCH),
which requires nonlinear tests in the dependent variable. The factor ARCH formulation
species a simple covariance matrix such that there will be a linear combination of the series
with no ARCH, while each of the series has ARCH. The ARCH tests are carried out in a
1 The concrete expression for each criterion can be found in Lutkepohl (1991). Testing whether the
residuals are white noise is based on the Ljung-Box statistic.

12
multivariate setting.
The factor ARCH model was used by Engle, Ng and Rothschild (1990) and Diebold
and Nerlove (1989) among others, in examining T-bills and stock portfolios and modelling
exchange rate volatility. In a simple version of the model, a vector of random variables
Y 2 RN with a factor ARCH structure with K factors has a conditional covariance matrix
Ht given by
X
K
E [(Yt t)(Yt t )0jFt ]  Ht =
+
1 k k0 !kt ; (15)
k=1
where t is the conditional mean vector and k's are linearly independent (Nx1) vectors.
The ith element of Yt will be autoregressive conditionally heteroscedastic if not all the ki
are zero.
To detect ARCH in this multivariate setting for each of the series in Yt, we have to regress
yit on a constant, a series of its own lags and lags of squares and cross products of the other
2

variables. Using the notation of Engle and Kozicki (1993), the test statistic can be expressed
as
s(yi) = yi 0Mxz(z0Mxz) z0Mx yi =k^yi ;
2 1 2
(16)

where z is the set of regressors, Mx = I (0) 0 with  a column of ones and k^yi is a
1

consistent estimate of the variance of yi . For k^yi = yi 0Mxyi =T , the test statistic is just
2 2 2

TR of the regression of yi on a constant and z and follows a chi-squared distribution with

2 2

rank(Z ) N + 1 degrees of freedom, being Z the set of regressors including the column of
ones.
In our case, stock returns and trading volume series form the vector Yt. Before implement-
ing the tests in a bivariate setting, we have computed the Ljung-Box statistics for 13th-order

13
serial correlation for the squares of the return series and 18th-order serial correlation for the
squares of the volume series, which are 287:66 and 2056:97, respectively, indicating that an
ARCH eect is present in each of the data series. In our bivariate setting, the two equations
can be expressed as

y t =  + B (L)y t + B (L)y t + B (L)y ty t + u t

2
1 11
2
1 12
2
2 13 1 2 1

y t =  + B (L)y t + B (L)y t + B (L)y ty t + u t;

2
2 21
2
1 22
2
2 23 1 2 2 (17)

where Bij (L) for i; j = 1; 2; 3 are lag polynomials of order ve . 2

The resultant TR statistics of the regression of each squared series on an intercept and
2

z = fy t ; : : :; y t ; y t ; : : : ; y t ; y t y t ; : : : ; y t y t g were calculated to be 200:79

2
1 1
2
1 5
2
2 1
2
2 5 1 1 2 1 1 5 2 5

for the returns series and 396:76 for the volume series with p-values of 0:000 for each case.
Therefore, there is evidence to reject the null hypothesis of constant conditional variance
against the alternative of ARCH in both returns and volume series.
Once we have evidence that the feature is present in both series we proceed to test for
the existence of a common feature or factor ARCH. To test for factor ARCH we have to
minimize s(u) in ( 16), where u = [u ; :::; uT ]0 and ut = y t y t where y and y are return
2 2
1
2
1 2 1 2

and volume series, respectively. The solution to:

s(^u) = min

u 0Mxz(z0Mxz) z0Mxu =k^u ;
2 1 2
(18)

requires nonlinear optimization. Using a grid search procedure, a value of ^ equal to 0.0042
solves ( 18). The TR statistics of the regression of ut = (y t y t) on a constant and
2 2
1 2
2

2 The order has been selected according to FPE and HQ criteria. SC and AIC criteria selected 3 and
18 lags, respectively. However, the results of the tests for ARCH eects in each of the data series as well as
those of the test for common feature do not change.
14
z = fy t ; : : : ; y t ; y t ; : : :; y t ; y t y t ; : : : ; y t y t g is distributed asymptotically
2
1 1
2
1 5
2
2 1
2
2 5 1 1 2 1 1 5 2 5

as a chi-squared with 14 degrees of freedom. The calculated test statistic value is 52:703,
which has a p-value of 0:00000214 clearly rejecting the null hypothesis of no ARCH.
Therefore we have found that there is evidence against the null hypothesis of no feature
(i.e. no ARCH) so the single-factor ARCH would not be a good description of the conditional
heterocedasticity found in the individual series of returns and volume.
The results of the tests carried out show that serial correlation, non normality and ARCH
are not common to daily volumen and stock return series. We only nd that skewness is
common to them. Therefore, it seems that if stock returns and volume are driven by a
common factor as the MDH suggests, this factor only exhibits skewness but no the other
features analyzed present in the individual series but not shared in common. Therefore,
those other features have to be explained by some other factor.
Another possible explanation is that features present in the common factor might be
transmitted to the variance of return series rather than to the mean. So we could test for
common features between volatility of returns and daily volume.
Lamoureux and Lastrapes (1990) oer an explanation for the presence of ARCH in stock
return series based upon the mixture of distribution models, in which the volume serves as
a proxy for the ow of daily information arrival, which is considered the stochastic mixing
variable. In order to examine the validity of this explanation they estimate a GARCH(1,1)
model for daily stock returns including daily volume in the volatility equation. They nd ev-
idence that the estimated coecient of volume is signicant and positive while the estimated
coecients of both lagged squared residuals and lagged volatility become insignicant, sup-

15
porting the hypothesis that the rate of information ow explains the variance of the stock
return process.
As Lamoureux and Lastrapes (1990), we also obtain the maximum likelihood estimation
of a GARCH(1,1) model for the stock return series of the type:

rt =  +  rt + ut
0 1 1

ut  N (0; ht )
ht =  +  ut +  ht
0 1
2
1 2 1 (19)

and compare the results with those of the estimation of a GARCH(1,1) including volume in
the volatility equation:

ht =  +  ut +  ht +  vt
0 1
2
1 2 1 3 (20)

The results of these estimations are depicted in Table 1, where asymptotic t-statistics
appear in parentheses. The results provide strong evidence that daily stock returns can be
characterized by the GARCH (1,1) model. When volume is not included in the volatility
equation (equation ( 19)), parameters  and  are both signicant and positive and the
1 2

sum ( +  ) approaches unity, meaning that the persistence of shocks to volatility is great.
1 2

On the contrary, when volume is included in the volatility equation (equation ( 20)), the
estimation results show that volume is highly signicant while  and  become insignicant.
1 2

The results obtained are similar to those in Lamoureux and Lastrapes (1990) and they
could be interpreted as supporting the MDH, in which volume serving as a proxy for in-
formation ow explains the variance of stock returns. The problem is that this approach
considers volume as a weakly exogenous variable. If volume is considered endogeneous this
16
 Table 1: Maximum Likelihood Estimates of GARCH(1,1)
ht =  +  ut +  ht
0 1
2
1 2 1
0  1  + 2 1 2
0.00001 0.12957 0.76697 0.89655
(7.29) (7.49) (29.03)
ht =  +  ut +  ht +  vt
0 1
2
1 2 1 3
0  1  2 3
-5.088e-005 2.323e-003 -0.430 2.700e-005
(-1.76) (0.48) (-1.96) (39.07)

result may be biased.

To avoid this problem we consider to test for serial correlation as a common feature to
return volatility and volume, where the relevant question is: do lagged return volatility and
volume actually provide information useful for forecasting both return volatility and volume
in a bivariate system? If this is so, it is due to a single component, say the ow of information
to the market?
Again, under the null hypothesis of "no feature" return volatility and volume are orthogo-
nal to the information set including lagged return volatility and volume. This orthogonality
condition can be tested estimating by least squares each equation of ( 4) and using the
statistic TR of the estimated regressions, as explained above.
2

The return volatility has been calculated as ht in the maximum likelihood estimation
of equations ( 19) taking h = u^ u^
0
as the starting value. Return volatility is depicted in
0 T
Figure 3.
Serial correlation is tested as a feature in each return volatility and volume series using
equations ( 4), where y is now return volatility and y , volume. The order selected for the
1 2

V AR model is 9 , which has been determined according to the criteria used for the case of

17
return and volume series, explained above.
The results of serial correlation tests are TR = 1192:214 with a signicance level of
2

0:000 for the return volatility series and TR = 305:002 with a signicance level of 0:000
2

for the volume series. The test statistic is asymptotically distributed as a chi-squared with
18 degrees of freedom. Hence, the null hypothesis of no serial correlation is rejected at
a 5% signicance level for each data series. Therefore there is evidence that lagged return
volatility and volume actually provide information useful for forecasting both return volatility
and volume.
The test for serial correlation as a common feature to return volatility and volume is
carried out using the procedure explained in section 2, where the instruments for the 2SLS
estimation of ( 7) are fconstant; y ;t ; y ;t ; : : : ; y ;t ; y ;t ; y ;t ; : : :; y ;t g. The value of
1 1 1 2 1 9 2 1 2 2 2 9

the test statistic is TR = 1109:655 with a signicance level of 0.000, which clearly indicates
2

that correlation is not common to volatility of returns and volume.

Table 2 summarizes the testing results, depicting the value of the test statistic for each
of the null hypotheses considered as well as the corresponding signicance levels in brackets.
As it can be seen, there is evidence that return and volume series are not normal presenting
skewness and kurtosis. They also present serial correlation and ARCH eects. However,
we only nd evidence of a common feature for skewness, that is, both stock returns and
trading volume have skewness but there is a nonzero linear combination of them such that
fails to have skewness. On the other hand, we have estimated stock return volatility as a
GARCH(1,1) and we have tested for common serial correlation between daily volume and
volatility of returns. Even though there is strong evidence that lagged return volatility and

18
 Table 2: Testing Results
RETURN VOLUME COMMON FEATURES
H : normality
0 H : normality
0 H : normality
0
JB (y ) = 1944.423
1 JB (y ) = 27979.903
2 JB (u) = 780.661
(0.000) (0.000) (0.000)
H : no skewness
0 H : no skewness
0 H : no skewness
0
SK (y ) = -5.84594
1 SK (y ) = -47.32824
2 SK (u) = -1.27958
(0.000) (0.000) (0.200)
H : no kurtosis
0 H : no kurtosis
0 H : no kurtosis
0
KU (y ) = 43.78385
1 KU (y ) = 160.63518
2 KU (u) = 27.88489
(0.000) (0.000) (0.000)
H : no serial correlation H : no serial correlation
0 0 H : no serial correlation
0
TR (y ) = 70.567
2
1 TR (y ) = 369.095
2
2 TR (u) = 68.781
2

(0.002) (0.000) (0.002)

H : no ARCH
0 H : no ARCH
0 H : no ARCH
0
TR (y ) = 200.798
2
1 TR (y ) = 396.767
2
2 TR (u) = 52.703
2

(0.000) (0.000) (0.000)

VOLATILITY RETURN VOLUME COMMON FEATURES
H : no serial correlation H : no serial correlation
0 0 H : no serial correlation
0
TR (y ) = 1192.214
2
1 TR (y ) = 305.002
2
2 TR (u) = 1109.655
2

(0.000) (0.000) (0.000)

19
volume actually provide information useful for forecasting both return volatility and volume
there is no evidence in favor that this is due to a single factor.

5 Conclusions
This article describes the theory and implementation of methods for testing for common
features in a bivariate system for Spanish daily return (or return volatility) and trading
volume. Data properties such as serial correlation, skewness, kurtosis and ARCH that are
in fact present in the data series are tested to be common to them.
The results of the tests show that although non normality, kurtosis and serial correlation
are features present in stock return and volume series, they are not common to them since
there is no linear combination of the data series such that fails to have the feature. Similar
results are obtained when testing for serial correlation in return volatility and volume series.
On the contrary, skewness is shared in common by both returns and volume series.
According to the MDH, there is a mixing variable, namely the information ow to the
market, which directs both return and volume. If this latent variable has any detectable
feature such as skewness, kurtosis, serial correlation, ARCH, then this feature should be
shared in common, that is, there should be a linear combination of them such that does
not have those features. The nding that only skewness is found to be a common feature
in return and volume series seems to invalidate one of the most relevant implications of
the MDH, the existence of a single factor driving both returns (or returns volatility) and
volume or, at least, if there exists a common factor it only has as a detectable feature, that
of skewness.
Tauchen, Zhang and Liu (1996) point out that models of trading volume that incorporate
20
a market microstructure and a latent information process (Tauchen and Pitts (1983), An-
dersen (1996) and Foster and Viswanathan (1995)) do not aggregate well, which motivates
testing volume-price relations using individual security data. Following these authors, the
use of average prices and average volume might not be adecuate in this context, therefore,
the results of the tests might be aected by this kind of aggregation. Research on common
features using data for individual stocks is in process.

21
 Figure 1: Stock Return Figure 2: Trading Volume
0.075 11

0.050 10

9
0.025
8
-0.000
7
-0.025
6
-0.050
5
-0.075 4

-0.100 3
55 326 597 868 1139 44 290 536 782 1028 1274

Figure 3: Return Volatility

0.00112

0.00096

0.00080

0.00064

0.00048

0.00032

0.00016

0.00000
61 342 623 904 1185

22
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