An empirical study of volatility and market quality

The aim of this study is to develop a simplified tool to measure pricing efficiency using volatility from price. Volatility is a major aspect of today’s markets and is considered a quintessential aspect that is rooted within practical applications of trading, investing, compliance, and risk management. Current developments and research concerning asset pricing incorporates the factors of market quality and liquidity, which can be reflected through volatility. What can be determined is whether public information derived from end of day pricing can be used to infer the market quality within a short time-frame. This study investigates over 2,000 active trading accounts from a leading broker, and concludes that information derived from volatility can act as a short term predictor of market risk. Within this framework, volatility is seen to be highly correlated with the number of margin calls and liquidations. This can serve as an objective indicator of market quality in general when used by risk management and traders alike during decision making processes.