Testing the mixture‐of‐distributions hypothesis using “realized” volatility

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Abstract
The mixture‐of‐distributions hypothesis (MDH) posits that price volatility and trading volume are both subordinated to the same information arrival rate or “news” process. Existing studies that test MDH have the problem that both the information arrival rate and volatility are unobservable. Recent work (e.g., Andersen et al., 2001) suggests that intraday returns can be used to construct estimates of daily return volatility that are more precise than those constructed using daily returns. In a way, realized volatility becomes observable. Conducting a number of tests of MDH we find that every conclusion based on the daily squared return is reversed when using realized volatility based on intraday returns. Hence, the mixed evidence on MDH in the existing literature can in part be attributed to the use of poor realized volatility measures. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:661–679, 2003