Relationship between Trading Volume and Security Prices and Returns

The relationship between trading volume and securities prices is a complex one which, when understood properly, can lead to many insights in portfolio theory. Over the past forty years, much work has been done trying to understand this relationship. In this document, we will attempt to introduce and discuss some of these papers. First, we introduce basic topics of finance theory, such as the Capital Asset Pricing Model and two-fund separation. With this knowledge, we proceed to discuss how volume and price move together, how unusual volume can be a predictive measure of future price changes, and also how volume can allow us to infer a hedging portfolio. In each case, we present theoretical models which support empirical results. Finally, we analyze some sample price and volume data around the most recent quarter of earnings announcements.