The empirical relationship between trading volumes and returns volatility at the Nairobi Stock Exchange

Abstract

The relationship between Trading Volume and Stock return volatility can lead to many insights in financial theory, particularly the Black - Scholes type derivative pricing formula. Knowledge of this relationship helps explain how returns are generated and the implications for inferring return behavior from trading volume data. Over the past ten years, much work has been done, mostly in developed stock markets, trying to understand this relationship. This paper presents an empirical analysis of the relationship between trading volume and returns volatility at the Nairobi Stock Exchange. Research was carried out on 20 companies, which constitute the NSE 20 Share Index that remained listed at the NSE and traded over five year period under study (1998 - 2002). The study used Regression as well as Correlation to determine whether there exists a relationship and the degree of association between trading volume and returns volatility. Daily trading volumes were used to construct monthly trading volume data while daily returns to construct monthly returns data. Return Volatility was arrived at through computation of Standard '~eviation of monthly returns. Correlation coefficient and Coefficient of Determination were used to find the relationship between returns volatility and trading volumes for the period under study. The findings show that there was no relationship between trading volume and returns volatility of the companies that constitutes NSE 20 Share Index. Specifically past history of the series cannot be used to predict the future in any meaningful way.