Volatility
Volatility is a crucial concept in finance, representing the degree of variation in the price of a financial instrument over time. It is often quantified using statistical measures such as standard deviation or variance, which reflect how much and how quickly prices fluctuate around a mean value.
Basic Definition
Annualized standard deviation of the change in price or value of a financial security.
Estimation / Prediction Approaches
- Historical / sample volatility measures.
- Geometric Brownian Motion Model
- Poisson Jump Diffusion Model
- ARCH/ GARCH Models
- Stochastic Volatility (SV) Models
- Implied volatility from options/ derivatives
Key Characteristics of Volatility
Types of Volatility
- Historical Volatility: This measures past price fluctuations based on historical data. It provides insights into how much an asset's price has varied over a specified period.
- Implied Volatility: This reflects the market's expectations of future volatility, derived from the pricing of options. It indicates how much traders expect the price to move in the future.
Measurement
Volatility can be calculated using standard deviation, which measures the average distance of each data point from the mean. The formula for annualized volatility is :
where