In their 2005 article, Gunduz and Hatemi-J have explored the relationship between stock price and volume by using information from the major stock markets of Central and Eastern Europe. They have made use of the Toda-Yamamoto (1995) procedure to determine Granger causality among the variables. The findings of their study provide insight into the different ways stock price and volume influence, and are influenced by, one another. In fact, in some cases, as in the Czech stock market, it was found that no causal relationship between stock price and volume exists. A unidirectional relationship was observed in some markets while in other markets a bidirectional relationship was observed. Therefore, a conclusive statement about the causal relationship between trading volume and price cannot be made.
The Importance of the Study
This is an important study for several reasons. Firstly, the authors have implemented their study in the Central and East European markets of Hungary, Turkey, Russia, Poland and the Czech Republic. These markets have been relatively less explored in academic research on stock prices because of their only recent growth. In comparison, the relatively mature stock markets of the world including the western capitalistic countries have been well researched. By focusing on the Eastern European markets, the authors have helped to shed light on the working of stock markets that are comparatively less integrated into the global financial and economic system. The study allows the readers to see the different dynamics at work in the stock markets to appreciate the role of various forces such as stock price, information flow, government control, and market turnover. The region has also been relatively less affected by the global financial crisis because of its relative independence of the global financial system. The study helps to highlight the aspects of an economic or financial system that may have allowed the area to remain buoyant while other regions faced the impact of the global crisis.
The study is also important because it is attempting to determine the causal relationship between the stock price and volume. In specific terms, it is trying to determine whether granger causality exists between the two variables in that one precedes the other. In most of the research, the relationship between the variables has not been studied from this perspective. The data has been used to show a contemporaneous relationship as in how stock price and volume are affected by a third variable and behave in response to changes in the third variable.
Another reason why this study is important is that it helps to understand the effect of forces such as information flow and financial institutions on the relationship between stock price and volume. The economies of Central and Eastern Europe have been controlled by the state historically and the financial institutions in place are remarkably different from the institutions of Western Europe and North America. This study helps to explain the role of information flow and financial institutions on the stock price and volume relationship in economies that are growing from a historically centralized form of control to a more open environment.
The study also shows how the Toda-Yamamoto procedure can be applied in a practical case of stock markets to determine causality among the factors being investigated. The authors have made asymptotic distributions to test for Granger causality among the variables. This study is therefore a testing ground for the Toda-Yamamoto procedure and its successful explanation of causality or noncausality can help to enhance the understanding of Granger causality. The test can then be applied to other settings for determining such causal relationships among different variables.
A Review of the Findings
The findings of the study fail to show a uniform behavior in the markets chosen for the study. For example, it was found that no causal relationship between stock price and volume or market turnover exists in the Czech Republic. The cointegration test results for the data from the Czech Republic stock exchange based on the Johansen-Juselius maximum likelihood procedure showed 0.0285 Eigen values and test value of 13.11. This score caused the researchers to avoid rejecting the null hypothesis that no causal relationship between the two exists. The findings of the other stock markets are also quite different from one another. But the findings for all the remaining stock markets show that a long-term steady cointegration exists between stock price and market turnover or volume.
In Hungary, for example, the researchers found that bidirectional causality exists between stock price and market turnover, and between stock price and volume. The bidirectionality implies that changes in stock price can bring about changes in market turnover or volume. In addition, changes in market turnover or volume can also bring about changes in stock price. In Poland, stock prices and volume show a bidirectional cointegration whereas market turnover is seen to cause a change in stock prices without any feedback effect. The findings in Turkey and Russia are more in line with the western developed markets. There is found to be a unidirectional causal relationship between stock prices and both volume and market turnover.
The authors interpret their results in the light of relative control and freedom over market activities, the flow of information and the role of institutions. They argue that since Russia and Turkey are the emerging markets of the region and better connected to the western financial markets, they demonstrate a clear unidirectional relationship because of the involvement of foreign investors in their stock markets and the relatively unrestricted flow of information.
Analysis of the Study
For more reliable and accurate results, the authors use the vector autoregressive model modified as a vector auto correction model. This model helps the authors to study the cointegration among the variables of interest more closely. Before using the VAR model, the authors then determine the optimal lag order to account for inconsistencies in the data. They also make a distinction between the two important measures of raw volume and market turnover. They use the term volume to refer to the total volume of shares traded in the stock market. They use market turnover to refer to the number of shares traded divided by the market capitalization. Although the two terms are used to measure the same thing in their model, the authors clearly state what form of share volume they are referring to.
Their findings show that there is cointegration among the variables stock price, volume and market turnover. The direction of the relationship and the magnitude differs among the countries chosen for the study. Although no correlation is seen in the case of the Czech Republic, there is a long-term relationship in other countries. In Russia, however, such a relationship does not exist between stock price and market turnover. Similarly, a long-term relationship between stock price and raw volume does not exist. The findings also show that a unidirectional relationship between stock price and both raw volume and market turnover exists in Turkey and Russia. The authors are of the view that this similarity in behavior between the mature western European markets and the markets of Russia and Turkey indicate that these have information flows similar to those in the developed markets. In the other countries chosen for this study, the bidirectionality has been attributed to a smaller size of the stock market and the existence of barriers to smooth information flow. The bidirectionality also implies that in the case of countries like Poland and Hungary the stock price does influence the volume of trade as the market forces of demand and supply adjust to the stock price. At the same time, the volume of trade can also be used to determine stock price in the future. For this reason, these markets have been termed by the authors as information-inefficient.
The authors originally intended to find a theory that could uniformly be applied to all the countries under study. However, the varying results do not allow interpretation in the light of a single theory. The experiences of all the countries can be explained by different theories. For instance, the bidirectionality can be explained with the help of the findings of Copeland (1976) who explains that changes in volume also carry information signals that determine stock price.
Critique of the Study
The article does not determine a theoretical explanation that can account for the behaviour of all the stock markets being studied. The authors have made an attempt to explain the dynamics of the stock market in Central and Eastern Europe, which have not been studied as extensively in research literature. This study may be quite useful in the present context because the European sovereign debt crisis is creating implications for the major and minor economies of the region. The biggest impact so far has been on Greece which is right next door to Turkey and Eastern Europe. The economies of this region are also heavily supported by the European Commission which has been one reason for their…