To read this content please select one of the options below:

Decomposition of stock market trade-offs using Shewhart methodology

Nadeeka Premarathna (Institute of Fundamental Sciences, Massey University, Palmerston North, New Zealand)
A. Jonathan R. Godfrey (Institute of Fundamental Sciences, Massey University, Palmerston North, New Zealand)
K. Govindaraju (Institute of Fundamental Sciences, Massey University, Palmerston North, New Zealand)

International Journal of Quality & Reliability Management

ISSN: 0265-671X

Article publication date: 3 October 2016

308

Abstract

Purpose

The purpose of this paper is to investigate the applicability of Shewhart methodology and other quality management principles to gain a deeper understanding of the observed volatility in stock returns and its impact on market performance.

Design/methodology/approach

The validity of quality management philosophy in the context of financial market behaviour is discussed. The technique of rational subgrouping is used to identify the observable variations in stock returns as either common or special cause variation. The usefulness of the proposed methodology is investigated through empirical data. The risk/return and skewness/kurtosis trade-offs of S&P 500 stocks are examined. The consistency of this approach is reviewed by relating the separated variability to “efficient market” and “behavioural finance” theories.

Findings

Significant positive and negative risk/return trade-offs were found after partitioning the returns series into common and special cause periods, respectively, while total data did not exhibit a significant risk/return trade-off at all. A highly negative skewness/kurtosis trade-off was found in total and special cause periods as compared to the common cause periods. These results are broadly consistent with the theoretical concepts of finance and other empirical findings.

Practical implications

The quality management principles-based approach to analysing financial data avoids the complexities commonly found in stochastic-volatility forecasting models.

Social implications

The results provide new insights into the impact of volatility in stock returns. They should have direct implications for financial market participants.

Originality/value

The authors explore the relevance of Shewhart methodology in analysing variability in stock returns through reviewing financial market behaviour.

Keywords

Acknowledgements

The authors would like to thank the anonymous reviewers for their comments. Nadeeka Premarathna received PhD grants from the Higher Education for the twenty-first century project (HETC, www.hetc.lk/) – Sri Lanka and the National Centre for Advanced Studies in Humanities and Social Sciences (NCAS, www.ncas.ac.lk/) – Sri Lanka. Nadeeka Premarathna is on study leave during this study and is supported by the University of Kelaniya, Sri Lanka. Final year of this study is funded by the WC grant, University of Kelaniya and the Institute of Fundamental Sciences, Massey University, New Zealand.

Citation

Premarathna, N., Godfrey, A.J.R. and Govindaraju, K. (2016), "Decomposition of stock market trade-offs using Shewhart methodology", International Journal of Quality & Reliability Management, Vol. 33 No. 9, pp. 1311-1331. https://doi.org/10.1108/IJQRM-08-2014-0128

Publisher

:

Emerald Group Publishing Limited

Copyright © 2016, Emerald Group Publishing Limited

Related articles