Volatility analysis and aggregate index variability decomposition: a methodological and practical framework

By connecting a set of revised methodologies consistently and coherently, this paper provides a methodological and practical framework for identifying the most volatile components of an aggregate index1 and the tools for decomposing its variability. The volatility of the aggregate index and its components are measured through the standard deviations of their monthly and annual variations. To complement this analysis, we discuss additional formal statistical tests for identifying components with the highest likelihood of influencing the volatility of the aggregate index. Once identified, the components are analyzed to determine whether they have sufficient impact to influence the volatility of the general index. In addition, we present an exercise in the decomposition of aggregate-index variations in order to illustrate the two elements of the general index: aggregate and idiosyncratic shocks. Aggregate shocks result either from macroeconomic effects that have an impact on most components or from the propagation of the shock among these components. Idiosyncratic shocks occur within specific components, mainly those with high relative weights. The proposed framework can be applied to the practical analysis of the Consumer Price Index (CPI) and other indices.