The Stock Return – Trading Volume Relationship in European Countries: Evidence from Asymmetric Impulse Responses

We investigate non-linearities in the stock return trading volume relationship by using daily data for 16 European countries in an asymmetric vector autoregressive model. In this framework, we test for asymmetries and analyze the dynamic relationship using a simulation based procedure for computing asymmetric impulse response functions. We find that stock returns have a significant influence on trading volume, but there is no evidence for the influence of trading volume on returns. Our analysis indicates that responses of trading volume to return shocks are non-linear and the sign of the response depends on the absolute size of the shock. Thus, using linear VAR models may lead to wrong conclusions concerning the return volume relationship. We also find that after stock markets go up (down), investors trade significantly more (less) in small and mid cap stocks, supporting evidence for the theories of overconfidence, market participation, differences of opinion, and disposition effect. JEL Classification: G12, G14, G17, C32