Stock price and trading volume relationship in Central European markets

Stock Price

Trading Value and Stock Price

relationship between trading volume and price

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.

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 stability during the economic crisis that started in 2007 in the United States and then took the entire global financial markets in its wake.

The Eastern European economies are also dependent on following the recommendations of the IMF that imposes restrictions on government support programs for these countries. Turkey is an example of an economy that has emerged successfully into economic success through the programs of the World Bank and IMF. These programs have required countries in the region to refrain from stimulus packages in order to boost economic growth. In this scenario, this study may prove helpful to economists in the region for determining ways in which the stock market can be made a driver of economic growth. The results of this study can be used by the individual countries to tailor their information flow mechanisms and improve stock trade regulations to enable investors to read stock market signals in time and make the correct investments to help the region grow into a mature financial market.

Comparison with other Studies

Brailsford (1994, p. 11) has conducted a study on the relationship between stock price and volume in Australia. Like Gunduz and Hatemi-J (2005), his study has also discussed the role of information in mediating the relationship between stock price and volume. Brailsford goes a step further to explain that information effects result in the stock price data not being normally distributed. This happens because current information based on past information results in a bigger change in volume than the previous change in volume. Brailsford also concludes that a significant relationship between stock price and volume (p. 28).

Sabri (2008, p. 9) has also researched on the topic of the relationship between stock price and volume of trade. In particular, he has focused on the degree of cointegration between stock price and volume of trade in the Arab stock markets. He concludes that a strong relationship exists between the stock price and the volume of trade. Changes in stock price can and do bring about changes in the volume of trade. He further explains that the volatility of the stock price cannot be explained as a spillover effect of other international stock markets, since Arab stock markets are not closely integrated with internationals stock markets. Sabri (2008, p. 9) discovered that the volatility and strength of correlation was greatest in the oil-producing Arab countries, leading him to explain the volatility as a response to volatile changes in the price of oil in the international markets.

Leon (2007, p. 182) also discusses the relationship between volume and stock return volatility and arrives at a similar conclusion as Gunduz and Hatemi-J (2005). Leon's research conducted in the regional stock market of West Africa, known as Bourse Regionale des Valeurs Mobilieres (BVRM) verifies Copeland's (1976) prediction that volume changes carry an informational content which can shape investors' perceptions and affect the stock price. He also concluded that the West African stock market is information-inefficient, which is similar to the findings of Gunduz and Hatemi-J (2005) in the Central and Eastern European markets.

Similar findings are also observed by Tripathy (2011) in her study on the relationship between volume and stock price in Indian stock markets. She also uses the Johansen cointegration test used by Gunduz and Hatemi-J (2005) in their study. She also finds a bidirectional causality between the trade volume and stock return volatility, which leads her to conclude as well that stock price changes carry informational value for investors (2011, p. 88).

Deo et al. (2008) also conducted a similar study on the relationship between trading volume and stock price volatility in selected Asia-Pacific stock market. They also used the Granger procedure to identify the sequential causation between volume and price. They discovered a bidirectional relationship reflecting that changes in price influence changes in volume and vice versa. They also conclude that price as well as volume changes carry informational value for investors, which explains the lagged effect.

Like the conclusion of Gunduz and Hatemi-J (2005) on the Turkish and Russian stock markets, the study of Pathirawasam (2011) on the relationship between volume and price in the Colombo stock exchange also explains a weak-form efficiency in the Colombo stock market. This shows that all the information of past volume changes can be reflected in the current price changes (p. 47).

The studies of Gunduz & Hatemi-J (2005) and other researchers mostly show that a bidirectional relationship exists between stock price and volume. Their studies are conducted in the emerging and frontier stock markets, which can account for the bidirectional relationship. In all the studies, there exists cointegration between stock price and volume and all studies prove a significant long-term correlation between stock price and volume. The only exception to this cointegration is in the case of the Czech Republic where a significant cointegration was not found and the null hypothesis was accepted.

On the basis of the findings of the above studies, it is recommended that the stock market regulators in emerging economies should ensure smooth information flow channels so that investors have access to information that is of interest to them. mechanisms should be in place that allow information about past and contemporaneous changes in price and volume to be accessible to all investors simultaneously. Although private sources of information may exist, making information symmetry difficult to achieve, the efficiency of markets can be increased if public information channels are also improved.