A Study of Mutual Fund Flow and Market Return Volatility

Abstract

In this paper, we examine the dynamics of the price change-trading volume relation at the aggregate market/index level. We introduce the use of a novel “volume dispersion” measure designed to proxy for the variability in firm-specific information flows across securities that comprise the market. Our results suggest that the price change-volume relation can be strengthened by the introduction of this measure. We also offer evidence of a positive relation between market volatility and trading volume and a negative relation between market volatility and volume dispersion. Furthermore, we demonstrate that lagged values of market level trading volume and volume dispersion can predict the next day’s index level volatility. Our findings remain robust when the implied volatility of the S&P 100 index options is used in the analysis. This suggests that index option traders need to pay close attention to both aggregate market level trading volume and volume dispersion to better capture the dynamics of daily market volatility.