Volatility

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Definition: Volatility


Volatility

Quick Summary of Volatility


Volatility relates to the movement in share prices. If the share has relatively large swings in price, or moves on a frequent basis it will be classed as a highly volatile share.



Video Guide For Volatility




What is the dictionary definition of Volatility?

Dictionary Definition


Volatility can refer to any basic process that complements a trigger mechanism.

In financial economics, volatility is a quantification of risk based on the standard deviation of an asset’s historical return.

To fix ideas, imagine that over the relevant period, a given asset has never returned more than 20% in a financial quarter on any dollar invested. Over the same period, the worst performance is a loss of 5% of the dollar.

In such a situation, a full plot of the returns by quarter would generally take the shape of the famous bell curve, or normal distribution. The 20% gain would be one “tail” of that curve. The 5% loss would be the other tail. Given an unskewed curve, 7.5% gain would be the mean asset return.

The “standard deviation” measures the width of the central hump of such a bell curve. That is also called the “volatility” of that asset because by definition the higher the number, the more wildly results may vary from quarter to quarter.

The volatility of an asset is crucial in the determination of the value of any future claim upon that asset.


Full Definition of Volatility


In finance, volatility is a statistical measure of the tendency of a security’s price to change over time.

Volatility is defined as the standard deviation of the return over time T. (For technical reasons, volatility is usually computed based on log return rather than return.) Volatility must be stated for a specific period of time, such as a day or a year. Implied volatility is the volatility suggested for the price of an underlying asset based on the price of an option on that underlying. Implied volatility is obtained by solving an option pricing formula such as Black-Scholes for the volatility variable using the current option price. Ordinarily, an option pricing model is used to price an option, using historical volatility. Thus a difference between implied volatility and historical volatility suggests that market participants believe a security’s performance will be different from past performance.

Beta is the usual measure of volatility. A beta of 1.0 indicates a stock that perfectly tracks an reference index such as the S&P 500 Index. A high beta stock is more volatile and changes more than the index. A low beta stock is less volatile and changes less than the index.

Portfolio management can include balancing beta to match a value suitable for the risk tolerance of the investor.

Investment strategies can include selecting high beta stocks during a bull market and low beta stocks in a bear market.


Related Phrases


Bear market
Beta
Bull market
High beta
Index
Investment
Low beta
Market
Market price
Portfolio management
Risk tolerance
S&P 500 Index


Volatility FAQ's


What is Volatility?

Volatility is a term that refers to both the magnitude and frequency of price changes in an asset. A risky asset is one with a high amount of volatility, as its valuation may span a wide range. On the other hand, a low rate of volatility translates into little or moderate price swings over time. An option on an asset is more valuable when the asset’s volatility is high, since the asset holder might earn a significant profit by waiting for the asset’s price to spike and then buying it; the difference between the option’s exercise price and the purchase price is maximised in this manner. A high level of volatility is seen less positively when it comes to retirement portfolios, as the portfolio’s final value can be extremely difficult to forecast.

How to Calculate Volatility

Volatility is calculated using the asset’s past price movements and is defined as the standard deviation of the asset’s price over a certain time period. Beta is a measure of volatility, as it compares a security’s performance to a benchmark (typically a major stock index). Thus, a beta of 1.2 indicates that an asset’s price varies 120% in response to a 100% change in the comparison index’s pricing, whereas a beta of 0.8 indicates that an asset’s price changes 80% in response to a 100% change in the comparison index’s pricing.

To calculate volatility, one must first determine the mean of a data set, then calculate the difference between each data item in the data set and the mean, square the deviations to eliminate negative values, add the squared deviations, and finally divide the sum of the squared deviations by the number of data items in the data set.


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Definition Sources


Definitions for Volatility are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 13th April, 2022 | 0 Views.