Volume Shocks and Expected Stock Returns

This paper shows that stocks with positive volume shocks are overvalued and exhibit negative returns in the Korean stock market. The results are summarized as follows: First, the long-short portfolio sorted on volume shocks (which is defined as difference of volume in this month and previous 24-month average volume) produces a negative and significant monthly return. Second, Fama-MacBeth firm-level cross-sectional regression results show that volume shock in this month has negative and significant explanatory power over the stock return in the following month, after controlling for a set of firm characteristics. Third, even after adding liquidity shock and volatility shock into the regression model as control variables, the explanatory power of volume shock stands robust. Overall, the results of the paper lend support to Miller(1977)’s argument that when trading volume increases due to investor disagreement, only optimistic investors’ opinion tends to be reflected into stock prices in the presence of limitation of short-selling, causing the overvaluation of the stock.