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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.

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.

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.

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

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

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