Trading volume and Arbitrage

Abstract

Decomposing returns into market and stock
specific components is common practice and forms the basis of
popular asset pricing models. What about volume? Can volume
be decomposed in the same way as returns? Lo and Wang
(2000) suggest such a decomposition. Our paper contributes to
this literature in two different ways. First, we provide a model
to explain why volumes deviate from the benchmark. Our
interpretation is in terms of arbitrage strategies and liquidity.
Second, we propose a new efficient screening tool that allows
practitioners to extract specific information from volume time
series. We provide an empirical illustration of the relevance and
the possible uses of our approach on daily data from the FTSE
index from 2000 to 2002.