Econometric modeling of trading volume as an optimism measure

Optimism is a psychological term describing the belief of someone in success or hopefulness and confidence in the making decision process. After Kahneman and Tversky’s “prospect theory” (Kahneman & Tversky 1979) the perception of the role of psychology in economic activities of investors totally changed. The works of these two authors revolutionized the academic study of human judgement. Use of the terms “heuristic and biases” caused errors in theoretical models to be explained as the result of the influence of human nature (Gilovich & others 2002). Trading volume on the stock exchanges mirrors market trends and signals from technical analyses. One can assume during the growth trends that an increase in trading volume describes the belief of investors in the bull market and during decreasing trends in the bear market. Both situations could be treated as symptoms of optimism and pessimism of investors.

The main goal of the article is the examine whether volatility could be an indicator of investors' optimism. The main hypothesis is that trading volume could be modelled by market risk (standard deviation of rates of return) using econometric models. The sign of the rate of return is a significant binary variable for econometrics describing trading volume. Different methods of estimation of the volatility parameter will be used in the research - from classical statistics to autoregressive conditional heteroskedasticity (ARCH)-type models. Differing lengths of the time window for the standard deviation calculation was taken into account. The 180-trading day window was chosen for the analysis according to similar past works (Majewska 2000). The data used to verify the hypothesis were taken from the Warsaw Stock Exchange and concern the selected stock exchange indexes listed on the Warsaw Stock Exchange.