Market volatility

A - B - C - D - E - F - G - H - I - J - K - L - M - N - O - P - Q - R - S - T - U - V - W - X - Y - Z

What is volatility?

Volatility is a fundamental principle in finance It is a measure of risk in the markets. It is a measure of the dispersion, frequency and amplitude of movements in the markets over a period of time. In mathematical terms, volatility is the standard deviation of a financial asset. 

Volatility does not indicate whether an asset or a market is rising or falling. Volatility only indicates whether there is a lot of variation from a trend.

The volatility of a stock, or of an asset in general, calculated as a percentage, reflects the magnitude of changes in that stock, both up and down, over a given period of time.
Indeed, the valuation of options requires the anticipation of future market movements, which, if they were to become erratic, would entail an increased risk for the option writer. Volatility is a statistical measure of the dispersion of returns on an asset. The purely mathematical definition would be the standard deviation of the returns of the underlying asset. Clearly, the higher the volatility, the greater the potential gain for the option buyer, the greater the risk taken by option writers. 

Volatility often refers to the degree of uncertainty or risk associated with the magnitude of changes in the value of the underlying asset. Volatility can be used to assign value to an asset and to assess the risk associated with holding it. High volatility means that the value of a security can potentially be spread over a wider range of values, the standard deviation has increased, and extreme events are more likely. This means that the price of the security can change significantly over a short period of time in either direction. Lower volatility means that the value of a security does not fluctuate greatly and tends to be more stable.

 

What are the types of volatility?

It is common to distinguish between: 

  • Historical volatility is a risk indicator calculated from historical prices. It describes the past and is therefore a picture of past movements.
  • Implied volatility – also known as market volatility – reflects the expectations of market participants regarding the magnitude of future variations. 

The greater the uncertainty about a stock, the higher its implied volatility. It can therefore be higher than the historical volatility. Similarly, after a strong crisis period, implied volatility may be lower than historical volatility if the market anticipates a period of calm after the storm.

On the spectrum of least- to most-volatile assets classes, the money market is the least volatile, the bond market is moderately volatile, and the stock market is the most volatile.

Banks offer a whole menu of derivative products that allow investors to speculate on or hedge against volatility. In the same way, some market indices allow us to measure and track this volatility, such as the ViX created by the CBOE (Chicago Board Options Exchange).