Price Change and Trading Volume: Behavioral Heterogeneity in Stock Market

The well-known Wall Street adage that states, “It takes volume to make prices move” has long suggested that there exists a positive correlation between absolute changes in stock price and trading volume. To practitioners who use technical analysis as their trading tool, trading volume has always been treated as a key signal to price change. Although many studies have empirically examined the nonlinear relationship between price change and trading volume, very few studies are able to provide a persuasive explanation for such price-volume relationship. This paper fills this gap by providing an explanation for such relationship under a framework of heterogeneous agent model with evolutionary switching mechanism. With the support of US stock market data, we first summarize some stylized facts on stock return and trading volume. We then mimic these facts using our model. The comparison between simulated and “real” time series shows that our model is not only able to replicate the seemingly chaotic fluctuations of the financial market but also able to explain how stock prices and trading volumes co-evolve with agents’ belief.