Trading Activity and Price Volatility in Corporate Bond Market

Description

Price volatility and volume are two of the most closely watched trading variables in the financial market. A bulk of literature has attempted to understand the relation between these variables. Most theoretical models of market microstructure have generated some sort of predictions for volatility and volume. Empirical investigations of the volatility-volume relation are thus essential for validation of theories. Understanding the volatility-volume relation is also important for trading strategies of portfolio managers, firm-level issuance decisions, and assessing market quality.There has been extensive research on the role of volume in financial markets and it has been shown that volume contains fundamental information about a security. Substantial evidence also indicates that the information flow induces trades and price volatility simultaneously, resulting in a positive relation between volatility and volume. In the trading market, volatility and volume are constantly monitored by practitioners who have a great deal of concern over trading risk, capital adequacy, price discovery and market quality. Recently, the issues of volatility, volume and liquidity are of particular interest to academicians and practitioners in the context of high frequency trading.Despite a vast literature on the relation between volatility and trading activity, there are few studies on this issue in the fixed-income markets. Most studies on this relation focus on the equity and derivatives markets. In this project, we would like to examine alternative hypotheses for this relation for corporate bond market. This will provide the first comprehensive evidence for the price volatility and trading activity relation in the corporate bond market. This project will also expand the current literature in several dimensions, such as (1). the contribution of non-informational factors to the relation between price volatility and trading activity; (2). the effects of liquidity and quality on the impact of trading on price volatility during different market conditions; (3). disentangle the effects of flight-to-quality and flight-to-liquidity and their interactions during the subprime crisis.Along these dimensions, we will try to document several unique findings pertaining to the corporate bond market. And our analysis of the impact of trading on price volatility during the financial crunch will provide new insights on the roles of liquidity and credit quality in times of stress.