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A reexamination of the relationship between volatility, liquidity and trading activity

Kyaw, Khine and Hillier, David (2013) A reexamination of the relationship between volatility, liquidity and trading activity. Pecvnia. Revista de la Facultad de Ciencias Económicas y Empresariales, Universidad de León, 2011. pp. 33-45. ISSN 2340-4272

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Abstract

We investigate whether the relationship between equity trading activity, market liquidity and return volatility at the portfolio level is similar to the relationship at the individual security level. For the very largest firm-size portfolio, higher trading activity is positively associated with greater liquidity and more volatile returns. However, despite the volatility-liquidity relationship being the same for smaller equity portfolios, we find that higher trading activity is negatively associated with liquidity for this grouping. These contrasting relationships are shown to be caused by the interdynamics between all three variables and once we control for these interrelationships, the contrasting results disappear. The findings contribute to the debate on market behaviour that has taken on renewed vigour in recent years.