The Impact of Day-Trading on Volatility and Liquidity

We examine day‐trading activities for 540 stocks traded on the Korea Stock Exchange using transactions data for the period from 1999 to 2000. Our cross‐sectional analysis reveals that day‐traders prefer lower‐priced, more liquid, and more volatile stocks. By estimating various bivariate VAR models using minute‐by‐minute data, we find that greater day‐trading activity leads to greater return volatility and that the impact of a day‐trading shock dissipates gradually within an hour. Past return volatility also positively affects future day‐trading activity. We also find that past day‐trading activity negatively affects bid‐ask spreads, and past bid‐ask spreads negatively affect future day‐trading activity. Finally, we find that day‐traders use short‐term contrarian strategies and their order imbalance affects future returns positively. This result is consistent with a cyclical behavior of day‐traders who concentrate their buy or sell trades at the bottom or peak of the short‐term price cycles, respectively.