Stochastic Volatility, Trading Volume, and the Daily Flow of Information*

We use state‐space methods to investigate the relation between volume, volatility, and ARCH effects within a mixture of distributions hypothesis (MDH) framework. Most recent studies of the MDH fit AR(1) specifications that require the information flow to be highly persistent. Using a more general specification, we find evidence of a large nonpersistent component of volatility that is closely related to the contemporaneous nonpersistent component of volume. However, in contrast to studies that fit volume‐augmented GARCH models, we find no evidence that volume subsumes ARCH effects. Since volume‐augmented GARCH models are subject to simultaneity bias, our findings should be more robust than these prior results.