The causes of stock market volatility in Australia

Colm Kearney · Kevin Daly

79 citations0/0 files storedApplied Financial Economics

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Financial Risk and Volatility Modeling Monetary Policy and Economic Impact Market Dynamics and Volatility

Abstract

The paper examines the extent to which the conditional volatility of stock market returns in a small, internationally integrated stock market are related to the conditional volatility of financial and business cycle variables. It employs a low frequency monthly dataset for Australia including stock market returns, interest rates, inflation, the money supply, industrial production and the current account deficit over the period from July 1972 to January 1994. A novel feature of the analysis is the estimation strategy employed to overcome the generated regressors problem which pervades some recent related research. Specifically, the procedure of employing a two-stage estimation process to first estimate conditional volatilities and then model their interrelationships yields inefficient estimates, introduces bias into a number of diagnostic test statistics and generates potentially invalid inferences. This problem is overcome in the current paper by jointly estimating the equation for the conditional volatility of stock market returns together with the equations determining the conditional volatilities of all variables included in the model using the generalized least squares (GLS) estimation procedure together with the Hendry general-to-specific modelling strategy. Among the most important determinants of the conditional volatility of the Australian stock market are found to be the conditional volatilities of inflation and interest rates which are directly associated with stock market volatility, and the conditional volatilities of industrial production, the current account deficit and the money supply which are indirectly associated with stock market conditional volatility. Among these variables, the strongest effect is found to be from the conditional volatility of the money supply to the conditional volatility of the stock market. By contrast, no evidence is found of volatility spillover from the foreign exchange market to the stock market in Australia.

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References

1982Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation 1988Testing for a Unit Root in Time Series Regression 1979Distribution of the Estimators for Autoregressive Time Series With a Unit Root 1987Expected stock returns and volatility 1987Time Series Regression with a Unit Root 1980On estimating the expected return on the market 1982The stochastic behavior of common stock variances Value, leverage and interest rate effects 1990Stock Returns, Expected Returns, and Real Activity

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