The Dark Side of Trading

This study investigates the effect of high trading volume on observed stock volatility. The motivation is that volumes of U.S. trading have increased more than 30-fold over the last 50 years, truly transforming the marketplace. Given existing work that links volume and volatility as simultaneously driven by fundamental information, we are specifically interested in the effect of increased trading controlling for such information. We investigate a number of settings, including a mix of natural experiments (exchange switches, S&P 500 changes, dual-class shares), the aggregate time-series of U.S. stocks since 1926, and the cross-section of U.S. stocks during the last 20 years. Our main finding is that, controlling for other factors, there is a reliable and economically substantial positive relation between volume of trading and stock volatility. The conclusion is that stock trading produces its own volatility above and beyond that based on fundamentals.