Information Asymmetry, Trade Size, and the Dynamic Volume‐Return Relation: Evidence from the Australian Securities Exchange

• Date: 01 August 2014
• DOI: http://doi.org/10.1111/fire.12048
• Published date: 01 August 2014

The Financial Review 49 (2014) 539–564

Information Asymmetry, Trade Size, and

the Dynamic Volume-Return Relation:

Evidence from the Australian Securities

Exchange

Yan g Su n

University of South Australia

Huu Nhan Duong∗

Monash University

Harminder Singh

Deakin University

Abstract

This paper investigates the influence of information asymmetry on the cross-sectional

variation of volume-return relation. We find that the dynamic volume-return relation within

medium-size trades has the most significant response to the degree of information asymmetry.

∗Correspondingauthor: Department of Banking and Finance, Faculty of Business and Economics, Monash

University, 900 Dandenong Road, Caulfield East, 3145, Australia; Phone: +61 3 9903 2032; Fax:+61 3

9903 2422; E-mail: huu.duong@monash.edu.

We gratefully acknowledge helpful comments from Bonnie F. Van Ness and Robert A. Van Ness (the

editors), and an anonymous referee. We thank Michael Chng, Charles J. Corrado, Saikat Sovan Deb,

Kingsley Fong, Henry Leung, and seminar and conference participants at Deakin University, RMIT

University,Indian School of Business – Hyderabad, Indian Institute of Management – Bangalore, GNIM –

Delhi, the 2011 Finance and Corporate Governance Conference, the 19th Conference on the Theories and

Practices of Securities and Financial Markets, and the 19th Annual Conference on Pacific Basin Finance,

Economics, Accounting, and Management for helpful comments and suggestions. We are grateful to the

Securities Industry Research Centre of Asia-Pacific (SIRCA) for providing the data used in our study.All

remaining errors are our own.

C2014 The Eastern Finance Association 539

540 Y. Sun et al./The Financial Review49 (2014) 539–564

Wealso show that the effect of information asymmetry on the volume-return dynamics migrates

to small-size trades in recent years, especially in larger stocks. These results are consistent

with the notion that informed traders prefer medium-size trades and this preference has shifted

to small-size trades. Our findings highlight the importance of incorporating informed traders’

trade-size decision in the examination of the dynamic volume-return relation.

Keywords: trade size, information asymmetry, volume-return relation

JEL Classifications: G10, G20, G24

1. Introduction

Trading volume contains information about future price behavior and a consid-

erable amount of literature investigates the effectof trading volume on return autocor-

relation (Morse, 1980; Gallant, Rossi and Tauchen, 1992; Campbell, Grossman and

Wang, 1993; Conrad, Hameed and Niden, 1994; Stickel and Verrecchia, 1994; Lee

and Swaminathan, 2000). However, prior studies provide contrasting results on the

volume-return relation at the aggregate market index level and the individual stock

level (Llorente, Michaely,Saar and Wang, 2002). In this paper, we examine the influ-

ence of information asymmetry on the cross-sectional variation in the volume-return

relation of individual stocks. More specifically, we test the prediction of Llorente,

Michaely, Saar and Wang (2002) that stocks that are associated with a high (low)

degree of information asymmetry exhibit more return continuation (return reversal)

on high-volume days.

Our study contributes to the current literature by incorporating informed traders’

trade-size decision into the analysis of dynamic volume-return relation. Specifically,

we separate trading volume according to the size of the trade and investigate under

which trade-size group the volume-return dynamics have the greatest reaction to the

extent of information asymmetry. We are inspired by the line of research highlighting

that informed traders may prefer trades of a certain size (Easley and O’Hara, 1987;

Barclay and Warner, 1993; Chakravarty, 2001; Alexander and Peterson, 2007; Blau,

Van Ness and Van Ness, 2009). Under the joint hypothesis that informed traders’

trade-size preference defines the degree of information content in different trade-

size groups, and the degree of information asymmetry is associated with the cross-

sectional variation of volume-return relation, we argue that the dynamic volume-

return relation within the size category where informed traders concentrate should

have the most significant response to the degree of information asymmetry. To the

best of our knowledge, this is the first study that highlights the importance of the

informational role of trade size in the analysis of the dynamic volume-return relation.

In addition, we extend the prior literature by examining the evolution of in-

formed traders’ trade-size preference and its effect on the relation between informa-

tion asymmetry and the volume-return dynamics. The modern algorithmic trading