African Journal of Business Management Vol. 1 (7), pp.

176-184, October 2007

Available online at http://www.academicjournals.org/AJBM
ISSN 1993-8233 2007 Academic Journals

Full Length Research Paper

An empirical study of the relation between stock return

volatility and trading volume in the BRVM
Ndri Konan Lon
UFR des Sciences Economiques et de Gestion, Universit de Cocody, BPV. 43 Abidjan, Cte dIvoire. E-
mail: konanleond@yahoo.com.
Accepted 10, October 2007

This paper investigates the relation between stock return volatility and trading volume in the regional
stock exchange of the West African Economic and Monetary Union called the Bourse Rgionale des
Valeurs Mobilires (BRVM), and draws implications for market players. Using daily data on stock prices
and trading volume over the period 2 January 2002 to 29 July 2005, the study tests for the Granger
causality between stock returns volatility and trading volume. The result of this test shows that volume
has predictive power for stock returns volatility, regardless of the measure of volatility used. This
finding seems to support the sequential information arrival hypothesis of Copeland (1976). The finding
also suggests a degree of market inefficiency in the BRVM. This finding is useful for regulators,
practitioners, and market participants for their success depend on their ability to forecast stock price
movements.

Key words: Regional stock market, BRVM, WAEMU, trading volume, stock return volatility, granger causality.

INTRODUCTION

The relation between stock price variability and trading
volume has been the subject of many empirical studies
over the past years. The major motivation for these
studies is the central role played by trading volume in the
pricing of financial assets through the arrival of new
information. That is, trading volume does not only play a
significant role in market information but also, reflect
information about changes and agreement in investors
expectations (Harris and Raviv, 1993). The general result
from previous studies is that there is a positive correlation
between trading volume and price variability (Karpoff,
i
1987) . However, to date existing studies on this import-
ant relation have been carried out on developed and
some emerging markets; none of them has tackled the
issue in the case of frontier markets.
The present study fills this gap and contributes to the
existing empirical research by examining the causal
relation between price variability and trading volume in
the regional stock market of West Africa known as the
Bourse Rgionale des Valeurs Mobilires (hereafter,
ii
BRVM) for the first time. Several reasons justify the
importance of this study. First, causality tests can provide
useful information on whether knowledge of past trading
volume improves short term forecasts of current and
future movements in stock prices and vice versa. More
can be learned about the market by studying the joint
dynamics of stock price variability and trading volume
rather than emphasizing the univariate dynamics of stock
prices (Gallant et al., 1992). Second, this study will
enable us to uncover whether the price-volume relation in
the BRVM exhibits different characteristics from those in
developed markets. In fact, the different characteristics of
the BRVM with respect to information flows and institu-
tional structure can provide new insight into the price-
volume relation. Trading volume and stock returns are
two important indicators of trading activity in a stock
market that are jointly determined by the same market
dynamics and may contain valuable information about a
security (Lo and Wang 2001). Trading volumes reflects
the cumulative response of investors to news, whereas
price fluctuations capture the impact of that news on the
average change in investors expectations. Studying the
relations between the returns variability and the low
volume in the BRVM will help us uncover whether the
BRVM exhibits a positive price-volume relations as found
in mature markets. Third, a good understanding of the
stock price-volume relation has significant implications for
asset pricing models, regulators, and other market parti-
cipants. Besides, Low trading volume and a cap on daily
price fluctuations are two main characteristics of the

BRVM that may affect the price-volume relation-ship.
Trading volume on a daily basis represents the total
number of shares that change hands in the market during
the day. Volume is generally used to interpret the streng-
th of the market. It is evidence that buying and selling of
stock is or is not happening. The BRVM, as a frontier
market exhibits low trading volume which simply means
fewer buyers and sellers. With little supply or demand in
the BRVM, those few buyers or sellers of a stock will be
able to dramatically affect the price of that stock. A
couple new buys can push the price up, just as a few
sells can push the price down. That increased volatility in
price causes other investors to get nervous or excited,
and their reactions in turn add to the volatility. One should
therefore expect low trading activity to imply high price
volatility in the BRVM.
The cap or the limits on daily price fluctuations require
all trades to be carried out within a certain range. If tra-
ders are unwilling to negotiate within the limits range,
trading will stop. Trading can resume anytime traders are
willing to negotiate within the limits. Price limits have
been studied thoroughly with regard to their influence on
volatility, price discovery and volume. The objective for
imposing limits on daily price fluctuations for stocks is to
iii
stabilize prices and reduce market volatility . Since the
BRVM exhibits high volatility, it is not surprising that
regulators have imposed a cap on daily price fluctuations.
However, given the scarcity of publicly available com-
pany-specific news due to less stringent require-ments
for information disclosure in the BRVM, only part of the
information will be revealed and transmitted through the
low trading volume when price limits hit. This will delay
the price discovery process and increase price uncertain
and volatility for buys and sells will be based on income-
plete information. Buys and sells will depend more on
investors beliefs and less on fundamentals. It is there-
fore expected that price limits will not reduce volatility in
the BRVM. The main result of this paper is that the know-
ledge of past trading volume improves the forecast of cur-
rent stock prices. This fact implies the inefficiency of the
BRVM.
The rest of the paper proceeds as follows. Section 2
provides a review of theoretical and empirical studies on
the price-volume relation. Section 3 makes a brief descry-
iption of the BRVM. Section 4 describes the data and its
construction. Section 5 presents the econometric appro-
ach followed by empirical results in section 6. Section 7
discusses the results and section 8 concludes the paper.
Literature review
Theories on the price-volume relation
This section reviews previous research on the relation
between stock price changes and trading volume. Karpoff
(1987) gives four reasons why the price-volume relation
is important: (i) it provides insight into the structure of fin-
Lon 177
ancial markets. (ii) It is important for event studies that
use a combination of price and volume data from which
to draw inference. (iii) It is critical to the debate over the
empirical distribution of speculative prices. (iv) It has sig-
nificant implication for research into futures markets.
Two competing models have tried to explain the causal
relation between stock price volatility and trading volume:
the sequential arrival of information models and, the mix-
ture of distribution models.
According to the sequential arrival information models
first proposed by Copeland (1976), and later extended by
Jennings et al. (1981), there exists a positive bidirectional
causal relationship between absolute values of price
changes and volume. These asymmetric information mo-
dels hypothesize that new information that reaches the
market is not disseminated to all market participants si-
multaneously, but to one participant at a time. The final
information equilibrium is established only after a sequen-
ce of intermediate or transitional equilibriums have occur-
red. Therefore, due to the sequence of information flow,
lagged absolute returns may have the ability to predict
current trading volume and, vice versa. Karpoff (1987)
notes that, these models rely upon a distinction between
optimists and pessimists, and the subsequent beha-
vioural distinction between the two groups. For example,
if investors are reluctant to realize losses and are more
likely to take profits, then volume in a bear market is likely
to be lower than volume in a bull market. However, these
behavioural features are not easily captured in a formal
model.
The mixture of distribution models of Clark(1973), Epps
and Epps (1976), and Harris (1986) which states that
price changes and trading volume relations are due to a
mixture of distribution, is another explanation for the cau-
sal relation between asset prices and trading volume.
These models show that asset prices and trading volume
are positively correlated because the variance of the pri-
ce change on a single transaction is conditional upon the
volume of that transaction. Therefore, the relation bet-
ween price variability and trading volume is due to the
joint dependence of price and volume on an underlying
common mixing variable, called the rate of information
flow to the market. This implies that price and volume
change simultaneously in response to new information.
In addition to the models above; the noise-trader models
of Delong et al. (1990) provide explanations for the cau-
sal relationship between asset returns and trading
volume. These models hold that because noise traders
activities are not based on economic fundamentals, they
tend to cause a temporary mispricing of stock prices in
the short run. However, stock price changes revert to
their mean because of the disappearance of the transi-
tory component in the long run. In these models, the
positive causal relationship running from stock returns to
trading volume is consistent with the positive feedback
trading strategies of noise traders, who trade on the basis
of past price movements. A positive causal relationship
178 Afr. J. Bus. Manage.
from volume to price changes is also consistent with the
hypothesis made in these models that price changes are
caused by trading strategies of noise traders.
Empirical studies on the price-volume relation
This section summarizes some empirical studies on the
dynamic relation between stock price and trading volume
or between volatility and volume in stock markets.
Hiemstra and Jones (1994) analyze daily returns on the
Dow Jones Industrial Average (DJIA), and percentage
changes in New York Stock Exchange trading volume
over the 1915 - 1946 and 1947 - 1990 periods, and find
no evidence of linear causality, but report significant
bidirectional nonlinear causality between returns and
volume. Given that this result may come from volatility
effects associated with the flow of information, Hiemstra
and Jones (1994) estimate an autoregressive conditional
heteroscedasticity (ARCH) model to control for the
persistence of volatility in returns. After controlling for
volatility effects, their modified Baek and Brock (1992)
test continues to provide evidence of significant causality
running from trading volume to stock returns. They also
argue that the bidirectional nonlinear causality between
returns and volume can not be explained entirely by a
latent variable effect attributed to the flow of information.
Richardson and Smith (1994), and Lamoureux and Las-
trapes (1994) further investigate this issue. They apply
the generalized method of moments (GMM) procedure
using daily price and volume for thirty firms. They fail to
find strong evidence to support the information flow app-
roach. Lamoureux and Lastrapes (1994) find that, acc-
ounting for serial dependence in the flow of information
does not eliminate the persistence in conditional volatility
for returns. Brooks (1998) using both linear and non lin-
ear Granger causality tests, provides extensive evidence
of bidirectional feedback between volume and volatility.
He used the square of the daily return as a measure of
the Dow Jones stock returns volatility. Lee and Rui
(2002) demonstrate that returns Granger cause volume in
the U.S.A and Japanese markets but not in England.
Meanwhile, they show that trading volume does not
Granger cause stock market returns on the stock exchan-
ges of the U.S.A, Japan, and England.
Generalized Autoregressive Conditional Heteroscedas-
ticity (GARCH) models have also been utilized to exa-
mine the price-volume relationship. Lamoureux and Las-
trapes (1990) find that the inclusion of contemporaneous
trading volume in the conditional variance equation elimi-
nates the persistence in the volatility. However, as noted
by Lamoureux and Lastrapes (1990), if trading volume is
not strictly exogenous, then there is possibly simultaneity
bias. One potential solution to this problem is to use lag-
ged measures of volume, which will be predetermined
and therefore not subject to the simultaneity problem.
Lamoureux and Lastrapes (1990) find that lagged volume
was insignificant. Brooks (1998) uses various GARCH-
type models to forecast volatility out-of-sample, and con-
siders their augmentation to allow for lagged values of
market volume as predictors of future volatility. Chen et
al. (2001) find that the persistence in EGARCH volatility
remains even after incorporating contemporaneous and
lagged volume effects.
Price-volume relation has also been the subject of res-
earch in the emerging markets of Asia and Latin America.
Most of these studies fall into three groups. The first
group deals with the contemporaneous relations between
price volatility and trading volume (Brailsford, 1996; Saat-
cioglu and Starks, 1998; Huang and Yang, 2001; Ahmed
et al., 2005; Asai and Unite, 2007; Girard and Rita, 2007).
The second group studies the dynamic causal relation
between stock price/ return and trading volume (Moosa
and Al-Loughani, 1995; Silvapulle and Choi, 1999; Wang
et al., 2005; Rashid, 2007). The third group investigates
both the contemporaneous and the dynamic causal price-
volume relation (Ratner and Leal, 2001; Mestel et al.,
2003; De Medeiros and Van Doornik, 2006; Mohd Nor
and Chin, 2007).
Brailsford (1996) uses both the squared returns and the
absolute value of the returns as measures of volatility. He
provides support for a positive relationship between trad-
ing volume and volatility for the Australian stock market.
Saatcioglu and Starks (1998) employ Latin America stock
data and document a positive relation between volume
and both the price changes and their magnitude. Study-
ing the relationship between trading volume and return
volatility, Huang and Yang (2001) for the Taiwan Stock
Market and Ahmed et al. (2005) for the Kuala Lumpur
Stock Exchange have concluded that persistence in ret-
urns volatility remains even after volume is included in
the conditional variance equation. Asai and Unite (2007)
study the relationship between stock return volatility and
trading volume in the Philippines and find (i) a negative
correlation between stock return volatility and variance of
trading volume, and (ii) a lack of effect of information arri-
vals on the level of trading volume. Girard and Rita
(2007) investigate the relation between volatility and volu-
me in 22 developed markets and 27 emerging markets
and find a negative relation between expected volume
and volatility in several emerging markets.
Moosa and Al-Loughani (1995) examine the price-vol-
ume relation for four Asian stock markets. Using monthly
aggregate price and volume data, they find that, there is
strong evidence for causality running from volume to ab-
solute price changes and from price changes to volume
in the case of Malaysia, Singapore, and Thailand. How-
ever, they report no causality for the Philippines. Silva-
pulle and Choi (1999) use linear and nonlinear Granger
causality tests to examine the dynamic relationship bet-
ween daily Korean stock returns and trading volume.
They find a bidirectional linear and nonlinear causality
between stock returns and volume changes. Wang et al.
(2005) examine the dynamic causal relation between

stock return volatility and trading volume for individual
stocks listed on the Chinese stock market as well as
market portfolios of these stocks and reached the conclu-
sion that the inclusion of trading volume in the GARCH
specification reduces the persistence of the conditional
variance dramatically, and the volume effect is positive
and statistically significant in all the cases for individual
stocks. Trading volume is found to play a role of proxies
of information arrivals for the two B share portfolios, but
not for the two A share portfolios. Rashid (2007) find
unidirectional linear Granger causality from stock returns
to trading volume and, unidirectional nonlinear Granger
causality from volume changes to stock returns in the
Karachi Stock Exchange.
Ratner and Leal (2001) examine the Latin American
and Asian financial markets and find a positive contem-
poraneous relation between return and volume in these
countries except India. At the same time they observed
that there exists a bi-directional causal relation between
return and volume. In Australia, Mestel et al. (2003) find a
weak support for a contemporaneous and dynamic rela-
tionship between stock returns and trading volume, imply-
ing that forecasts of one of these variables cannot be
improved by knowledge of the other. Besides, they find
evidence of a strong contemporaneous relationship bet-
ween return volatility and trading volume and that return
volatility contains information about upcoming trading
volume. De Medeiros and Van Doornik (2006) investigate
the empirical relationship between stock returns, return
volatility and trading volume using data from the Brazilian
stock market (Bovespa) and find a positive relationship
between return volatility and trading volume and, a mut-
ual Granger causality between stock returns volatility and
trading volume although more intensely from volume to
volatility. Mohd Nor and Chin (2007) using index price
and trading volume data from the Kuala Lumpur stock
exchange find significant causal relations between trad-
ing volume and return volatility in accordance with the
sequential information arrival hypothesis.
The regional stock market of West Africa
The regional stock exchange of West Africa, known as
the Bourse Rgionale des Valeurs Mobilires (hereafter,
BRVM), was established on 18 December 1996, and be-
gan its operations on 16 September 1998. It is the stock
exchange of the West African Economic and Monetary
Union (WAEMU). The BRVM is responsible for organi-
zing the securities market and distributing related infor-
mation. To that end, it guarantees the listing of securities
on the exchange, the quotation of securities, the publica-
tion of market prices and information, the promotion and
development of the securities exchange.
The BRVM is headquartered in Abidjan, Cte dIvoire,
and represented in every member state by a national
branch office charged with: 1) overseeing public relations
for the exchange and the central clearing house; 2) dis-
Lon 179
disseminating market information; 3) assisting brokerage
firms and other market stakeholders; 4) organizing local
promotion of the regional exchange. At its inception, the
BRVM has two sections for stocks and a single section
for bonds with eligibility conditions differing across sec-
tions. A company seeking to be listed on the BRVM must
satisfy the following conditions: 1) be incorporated; 2)
sign a written agreement to publishing the annual state-
ments in the official newsletter, and to participate in the
organization of the exchange; 3) sign a written agreement
to obey the rules and regulations of the BRVM; 4) to
apply for listing on the BRVM, the candidate company
must mandate a brokerage firm to assist and advise it.
The BRVM is a centralized spot exchange driven by
orders, that is, the price of a security is fixed by matching
bid and ask orders. The quotation is done by fixing, that
is, single prices are obtained by matching bid and ask
orders. Currently, there are five sessions a week.
Two BRVM market indices represent the activities of
stock market shares: the BRVM Composite comprises all
securities listed on the exchange, and the BRVM 10 is
composed of the ten most active companies on the ex-
change. As of 17 March 2006, 39 companies are listed
on the BRVM.
Formulation and selection criteria for the BRVM inde-
xes are based on the leading global market indexes, esp-
ecially, the FCG index of the International Finance Corpo-
ration, a World Bank affiliate. The formulation of the inde-
xes takes into account market capitalization, transaction
per session, and transaction frequency. Only common
shares are used to calculate the indexes. The indexes
are automatically generated by the BRVM trading system
and circulated after every session. The BRVM 10 is rev-
iewed four times a year, and the BRVM Composite after
every new listing.
Table 1 shows some performance indicators of the
BRVM from 31 December 2002 to 29 July 2005. This tab-
le reflects the high performance of the BRVM 10 and
shows how volatile the regional stock market is.
The data and measurement issues
Data source and sample periods
The reliability of available data and the insufficiency of
computerized database have limited studies on frontier
markets and particularly on the BRVM. Since 2005, the
data problem was partly resolved by the BRVM which
posted on its website in PDF format, the Official News-
letter or Bulletin Officiel de la Cote (BOC) of the Bourse
Rgionale des Valeurs Mobilires. This newsletter gives
all the exchange statistics and the prices of the securities
listed (stocks, bonds, rights). The official newsletter dat-
ing from September 16, 1998 till now, can be found on
the BRVMs website. It will be interesting that the BRVM
builds in the short run a computerized database.
180 Afr. J. Bus. Manage.
Table 1. Selected figures of the BRVM.
Capitalization 31 December 2002
BRVM 10 465 634 264 590
BRVM Composite 832 398 094 700
Number of firms
BRVM 10 10
BRVM Composite 39
Some measures
Volume traded of stocks 4 823
Total value traded (CFAfr) 171 254 520
# of transations 30
# of securities traded 9 15
Notes: 1 Euro=655.957 CFA Fr. The CFA Fr is the currency unit of the West African Economic and Monetary Union (WAEMU)
eight (8) member States. Source: Official Newsletter of the BRVM.
The data set used in this study comprises daily closing
prices on the BRVM10 index and trading volumes obtain-
ed from the official newsletter of the BRVM. The study
period ranges from 2 January 2002 to 29 July 2005, the-
reby making 893 daily trading volume and closing prices
of the BRVM10 index. Both series are expressed in the
local currency. The choice of the BRVM10 index is moti-
vated by two reasons: first, it is composed of the ten most
actively traded stocks of the thirty nine quoted stocks in
the BRVM and, second, on average, it accounts for about
65% of the total market capitalization (Table 1).
Measurement issues
I compute in this section, the returns series, the volatility
series and the volume series to be used in this study. I
compute the daily stock market returns, Rt , as follows:
Rt = 100 * ln(Pt / Pt 1 )
Where Pt represents the value of the BRVM 10 price
index for the period t ; and t is the time in days. Pt 1 is
BRVM 10 index price for the period t 1 ; ln(.) is the
natural logarithm operator. All returns are expressed in
local currencies and are not adjusted for dividends. I also
use two measures of volatility in this study: first, the
widely used measure of volatility is the squared of returns
series (Brooks, 1998) and second, the absolute value of
return series (Saatcioglu and Starks, 1998). The volatility
of the returns series at time t is noted as Volatility t . It is
measured by either the absolute value of returns at time
t noted as Rt or the squared of returns series at time t
2
noted as Rt . According to the official newsletter, the
BRVM provides three measures of trading volume: i) the
31 December 2003 31 December 2004 29 July 2005
617 337 595 495 607 239 551 350 766 467 440 025
858 140 223 580 1 005 047 884 085 1 094 198 936 835
10 10 10
39 39 39
2994 2 031 1 033
72 584 325 35 861 220 47 493 520
85 28 25
8 8
volume traded is the sum of the number of shares traded.
For example, if we trade 20 shares of the company CIE,
10 shares of the company Sodeci, and 15 shares of the
company Solibra, then the volume traded is 45; ii) the
number of securities traded is simply the sum of the
company that trade securities. For example, if CIE,
Sedeci, and Solibra trade some shares, then the number
of securities traded is 3; iii) the total value traded
expressed in CFA Fr is the sum of the price of shares
traded times the volume traded and, iv) the number of
transactions. I use the total value traded or the CFA Fr
value of the shares traded in this study as the measure of
trading volume because it takes into account the relative
market value of individual shares while other measures
mentioned above do not. The volume series at time t
noted as Volumet is expressed as:
Volumet = ln(VOLt ) (1)
(1)
Where VOLt is the CFA Fr value of the shares traded at
time t and ln(.) is the natural logarithm operator. The
utilization of the natural logarithm of the volume series
will improve their normality.
Econometric approach
The relationship between returns volatility and trading
volume is examined using Granger causality tests. A
process is said to exhibit Granger causality when past
information on one variable improves the prediction of a
second variable in a better fashion than a prediction is
based on past information on the second variable only.
Consequently, Granger causality between two variables
can run in either or both direction. Testing for Granger
causality can be conducted within the context of a vector
autoregressive (VAR) model. The benefit of VAR models
is that they account for linear intertemporal dynamics bet-

ween variables, without imposing a priori restrictions of a
particular model. Hence, they are ideally suited to detect
stylized facts in data. Let Volatility t be the stock returns
volatility and Volumet , the trading volume, then the
following vector autoregressive representation is used to
test for the causality between returns variability and
trading volume:
p1 p2
Volatilityt = 0 + 1,i Volatilityt i + 2, i Volumet i + 1,t
i =1 i =1
p3 p4
Volumet = 0 + 1, i Volatilityt 1 + 2, i Volumet i + 2, t
i =1 i =1
Where R ,t and V , t are supposed to be independently
and identically distributed processes with mean zero and
constant variance, and the pi ' s are the optimal lag len-
gths. Within the context of this VAR model, linear Gran-
ger causality restrictions can be defined as follows: if the
null hypothesis that all 2 s jointly equal zero is rejected
in equation (3), it is argued past volume has an influence
on stock returns volatility or volume does Granger cause
stock returns volatility. Similarly, if the null hypo-thesis
that all 1 s in equation (4) jointly equal zero is rejected, it
is argued that volatility does Granger cause volume. If
both of the null hypotheses are rejected, bidirectional
Granger causality, or a feedback relation, is asserted to
exist between the variables.
Different test statistics have been proposed to test for
linear Granger causality restrictions. This study relies on
the conventional chi-square test for joint exclusion res-
trictions. Evidence reported in the literature suggests that
this simplest form of linear causality test outperforms
other causality tests in a series of Monte Carlo experi-
ments (Geweke et al., 1983). The test for causality used
in this study is based on the following Wald test statistics:
2 ( pi ) = (c C )' [C x C ' ]1 (c C ), i = 2 , 4 (3)
Where c is a ( p x 1) vector of known constants, C is a
( p x k ) hypothesis design matrix of known constants,
is a (k x 1) vector of the regression coefficients, and x
is the estimated covariance matrix of the regression coef-
ficients. A statistically significant 2 implies that lagged
values of the independent or predetermined variable help
to predict the dependent variable.
Empirical results
Unit root tests
Unit root tests are important in the time series analysis as
the choice of the techniques and procedure for further
Lon 181
analysis and modelling of series depends on their order
of integration. Without taking into account the presence of
unit root in the variables, the analysis may produce
spurious results. Furthermore, the Granger causality test
assumes that the returns and the volumes series are
stationary. Therefore, I test for the integration order of
each series by applying the augmented Dickey-Fuller
(ADF) test. The test is carried out by estimating equation
(5) below:
p
(1)
yt = t + t + yt 1 + j yt j + t (4)
j =1
Where yt represents either the returns series or the
(2) volume series; t is a white noise and t is a deter-
ministic linear trend. The ADF test tests the null hypo-
thesis ( = 0 ) of a nonstationary process against the
alternative hypothesis of a stationary process. The null
hypothesis of unit root is rejected if the Dickey-Fuller
pseudo-statistics are inferior to the reported critical
Mackinnons values. The tests results are presented in
Table 2. Owing to the importance of stationary series for
the study, I apply a second test of unit roots to the returns
and volume series: the Phillips and Perron (PP) test
which is robust to heteroscedasticity. The results are also
reported in Table 2.
The results from Table 2 show that the ADF statistics
as well as the PP statistics are all inferior to the
McKinnon critical value at the 10% level. This indicates
that the null hypothesis of unit root is rejected for the
stock returns, trading volume, the squared of stock
returns, and the absolute value of stock returns series.
These series are therefore stationary at level. They will
be used as such for the remaining estimation. These
series need not be subject to a cointegration analysis.
Granger causality tests estimates
The analysis begins by estimating the bivariate VAR
models in equations (3) and (4), using the stock returns
volatility and volume data series to examine the linear
linkages. The lag lengths for the VAR systems are deter-
mined by the Akaike Information Criterion (AIC). The
parameters in equations (3) and (4) are estimated by
ordinary least squares, and Whites (1980) heteroske-
dasticity-consistent standard errors are calculated. Table
3, below reports the results of Granger causality tests
between squared returns and trading volume, and bet-
ween absolute returns and trading volume.
Panel A of Table 3 shows the results of Granger cau-
sality between volatility measured by the squared of ret-
urns and volume, and Panel B of Table 3, the Granger
causality between volatility measured by the absolute
value of returns and volume. The null hypothesis that vol-
ume does not Granger cause volatility is rejected in Panel
A and Panel B. In effect, the 2 statistic that tests the
exclusion of the volume series in the volatility equation is
182 Afr. J. Bus. Manage.

Table 1. Unit root tests.

Series Lags Augmented Dickey-Fuller test statistics Phillips-Perron test statistics

Rt 14 -12.2161* -114.7989*
Volume t 1 -17.8454* -25.7461*
2
Rt 19 -6.6210* -15.9709*
Rt 19 -6.5965* -16.0170*
Notes: Table 2 reports the results of unit roots tests on stock returns, trading volume, and measures of vola-
2
tility. Rt , Volumet , R t , and Rt are the stock returns, the trading volume, the squared of returns, and the
2
absolute value of returns respectively. Rt and Rt are measures of volatility. The critical value at the 10%
significant level is -3.13. * indicates significance at the 10% level.

Table 2. Granger causality tests between stock returns volatility and trading volume
from 2 January 2002 to 29 July 2005.

2
Panel Null hypothesis -Statistics
2 35.5008*
Volumet does Granger cause Rt
(0.0278)
Panel A
2 12.3209
Rt does not Grange cause Volumet
(0.8715)
Volumet does not Granger cause Rt 29.5629**
(0.0576)
Panel B
Rt does not Grange cause Volumet 12.5607
(0.8603)
2
Notes: Rt and Rt are the squared of returns and the absolute value of returns respectively.
They are measures of volatility. The VAR model is estimates with 19 lags in both panels. p-
values for statistical significance are given in parentheses. * and ** indicate significance at the
5% and 10% respectively.

significant at the 5% level in Panel A, and at the 10%
level in Panel B, whereas the 2 statistic in the volume
equation is insignificant in both panels. There is there-
fore, a unidirectional Granger causality running from volu-
me to volatility but not vice versa. This means that, volu-
me does contain predictive power for the direction of
price changes or it is possible to use lagged values of
volume to predict volatility. In both panels, this causal
relationship is robust to the measures of volatility used.
The finding of unidirectional causality running from volu-
me to volatility is consistent with the results from emerg-
ing markets of East Asia (Moosa and Al-Loughani, 1995)
and Latin America (Saatcioglu and Starks, 1998).
DISCUSSION
The analysis points out to two main findings. First, there
is a unidirectional causality running from volume to vola-
tility. This is consistent with the sequential information
arrival models of Copeland (1976) which, imply that the
volume reflecting the arrival of new information causes
stock prices to change. Second, the finding is however,
unsupportive of the hypothesis of market efficiency since
it suggests that knowledge of publicly available informa-
tion like trading volume can be used to forecast stock
price variability.
Two important markets characteristics which are rele-
vant to the price-volume relation and the informational
inefficiency in the BRVM are the existence of price res-
trictions on price movements, and non synchronous trad-
ing.
iv
Maximum price changes allowed in a trading day will
certainly hinder, to some extent, information transmission
mechanism, that is, from news announcements to reali-
zed price changes. Only part of the information will be
reflected in the price changes.
Infrequent trading also produces some predictability in
the BRVM. If volume reflects the arrival of new informa-
ion, relationship between current observed index level
and past change in volume may be observed. Although, I
use the BRVM10, an index composed of the most active-

ly traded stocks; all stocks do not trade simul-aneously.
Furthermore, some stocks do not trade frequently.
These findings have implications for market regulators,
traders and market efficiency.
The finding of a causal relationship running from trad-
ing volume to stock returns volatility is important for mar-
ket regulators as they decide on the effectiveness or the
appropriateness of market restrictions such as daily price
movement limits and position limits. For example, increa-
sed volume may lead to increased price fluctuations,
which in turn may trigger more regulation of the BRVM.
However, the appropriateness of such regulation may
depend on the cause of price variability. Significant regu-
latory restrictions can be achieved if increased price fluc-
tuations are caused by increased trading volume.
The present results have also practical implications for
the activities of traders and other market players. The fact
that knowledge of past trading volume improves the
ability to forecast prices, should lead to the construction
of more accurate hedge ratio and improvements in
investment strategies. This corroborates the notion that
successful hedging and speculation strategies depend on
the ability of market players to forecast stock returns.
The fact that lagged trading volume contains informa-
tion useful for the prediction of current stock returns
volatility implies the inefficiency of the regional stock
market. A plausible explanation for this inefficiency is that
traders condition their prices on previous days trading
volume as a measure of the market consensus.
Conclusion
This paper has examined the relationship between trad-
ing volume and stock returns volatility in the regional
stock market of the West African Economic and Monetary
Union called the Bourse Rgionale des Valeurs Mobili-
res (BRVM). Using daily data on stock prices and trading
volume from the official newsletter of the BRVM for the
January 2, 2002 to July 29, 2005 period, the study tests
for Granger causality between stock returns volatility and
trading volume within a VAR framework. The study rev-
eals a one-way causality running from trading volume to
stock returns volatility regardless of the measures of vola-
tility used. This result may be due to the maximum ceiling
imposed on price changes and non synchronous trading,
which hinder the transmission mechanism. The result
teaches us that, the use of publicly available information
such as past trading volume to forecast current prices
implies the inefficiency of the BRVM.
Finally, the study has important implications for the
market regulators and other market players for their suc-
cess depend on their ability to forecast stock price move-
ments.
Endnote
i. Karpoff (1987) provides an extensive review of the lite-
Lon 183
rature on the relation between price variability and trading
volume.
ii. BRVM=Bourse Rgionale des Valeurs Mobilires. It is
the regional stock market of the West African Economic
and Monetary Union (WAEMU). The WAEMU is compo-
sed of eight countries (Benin, Burkina-Faso, Cte dIvoi-
re, Guine Bissau, Mali, Niger, Sngal and, Togo) using
the same currency: the CFA Fr. Euro 1= 655.957 CFA Fr
(a fixed rate).
iii. Many studies have tackled the issue of the impact of
price limits on stock market volatility but ended up mixed
results. Advocates of price limits believe that it will reduce
the volatility of stock markets and Opponents of the price
limits argue that it will not help in reducing price volatility.
Al-Khouri and Mohd M (2007, p. 166) provides a review
of the literature on price limits.
iv. There is a 7.5 percent upper limit and lower limit on
the percentage price change during a single trading day
at the BRVM.
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