Deviation Risk Measure

Definition of Deviation Risk Measure

A function which is implemented in financial mathematics to quantify financial risk with a different method, not just the general risk measure is defines as Deviation risk measures, which supports the concept of standard deviation.

Standard deviation risk measure is defined as a measure the process that contains set data, and the more data is processed the deviation goes higher. The calculations of standard deviation are done by square root of the variance. In the field of finance, the standard deviation is implemented on the annual rate of return of investment to learn the measurement of investment's volatility.

Standard deviation is dubbed as historical volatility; the most usage of this process is done by the investor as a gauge for the amount of expected volatility.

The mechanism of this system is interpreted in mathematical terms as follows,

 [1/n *  (r_i - r_ave)²]^½

Books on Deviation Risk Measure

Book 1:

Managing Downside Risk in Financial Markets: Theory, Practice and Implementation, Volume 1 By Frank Alphonse Sortino, Stephen Satchell (published by Butterworth-Heinemann, 2001)

Book 2:

Understanding Financial Management: A Practical Guide By H. Kent Baker, Gary Powell (published by John Wiley & Sons, 2009)

How Deviation Risk Measure works?

• Standard deviation is interpreted by statistical measurement with the intent to highlight on historical volatility, if an example is taken into consideration, while a volatile stock will generate a high level of standard deviation but at the same time the deviation of a stable blue chip stock will be lower in deviation measurement. With the help of a large dispersion, the amount of deviating return can be calculated in comparison to the expected normal returns.

• Suppose a person has the intention to invest in ABC company stocks, which has returned an average 10% per year for the last 10 years, so the person wants to compare the risk factor between ABC Company and XYZ Company, so he has to take a look at the year-by-year returns that compose that average. After going through the assessment, the person has come up with that Company ABC averaged 10% return over ten years but did so with far less variance than Company XYZ.

Standard deviation = √(3,850/9) = √427.78 = 0.206

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