What is Volatility?

In finance, volatility refers to the fluctuation of an asset or financial instrument’s price over time, measured by the standard deviation of logarithmic returns. Volatility quantifies the variations in the price of a commodity, currency, index or security.

High volatility implies huge upwards and downwards movement over a relatively short period of time, while low volatility would indicate smaller and less frequent changes in value.

The most common way to calculate volatility is to look at the beta coefficient, which measures the movements of a financial instrument against a baseline throughout a historical period. For instance, to calculate the volatility of a given stock within an index, the index is assigned a beta of one. Thus, a stock with a beta of one should move in line with the market, whereas a beta greater than one would be expected to be more volatile than the market as a whole.  Bigger figures like a beta of two, should rise 20% for every 10% that the broader market moves.

Types of volatility

There are many different types of volatility, as you can see below:

  • Actual current volatility is based on historical prices, starting with a specific date in the past all the way to the present.
  • Actual historical volatility is also based on historical prices, but those prices are not current; the last price used in the calculation is in the past.
  • Realised volatility is more complicated. It is the square root of the realised variance, calculated using the sum of squared returns divided by the number of observations.

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Category: Financial Glossary

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