Statistical Factors Principally Driving the Volatility of Australian Stocks Through the Business Cycle

ABSTRACT This study examined the principal factors driving the return volatility of a basket of Australian stocks, with the aim of understanding the volatility behaviour of such factors over the business cycle. Special focus was placed on unusual market events identified during the business cycle, such as the Covid‐19 pandemic. The study analysed monthly stock return and seasonally adjusted quarterly real GDP data from June 2011 to December 2024 using PAF and HP filter models respectively. The results showed that four factors accounted for around 67% of the return volatility of the stocks sampled. Factor 1 was primarily driven by REIT stocks, Factor 2 by bank stocks, Factor 3 by industrial and metal stocks and Factor 4 by coal, oil and gas stocks. These four principal factors exhibited unusual downside volatility levels over one subperiod of the business cycle, namely the first wave of the Covid‐19 pandemic. An implication of this study from the investment function perspective of the economy concerns the impact of overexposure to unusually volatile stock sectors by major fund providers. A particular issue concerns the rising interconnectedness between Superannuation funds and overinvested sectors, particularly the noticeable exposure to major local banks and the potential impact such an overexposure may have on financial market stability during periods of market volatility.