The Volume - Return Relationship under Asymmetry of Information and Short Sales Prohibitions

In the presence of asymmetric information, stock trading is particularly affected when market participants are prohibited from short selling. Although insiders privy to negative information may not exploit this information by selling if they do not own the stock, the market maker can deduce the occurrence of bad news by observing the trading patterns. Prices are shown to rise on high volume after good news and fall on low volume given bad news; furthermore, the speed of adjustment is greater on bad news, that is, the price falls more quickly to a lower equilibrium price than it rises to the price corresponding to good news. The second result depends upon parameters determining the structure of the market in terms of the types of participants (informed or uninformed) and their relative holdings of the stock. The volume anomaly is confirmed by an empirical study of trading on the Stock Exchange of Thailand, where short sales are prohibited. The results show that high trading volume in a given day is a strong indicator of high expected returns in the next period for almost all the stocks in our sample.