Fundamental Financial Concept: Volatility

Definition of Volatility

In the field of finance, a measure for variation of a financial instrument price over time is recognized as volatility. The application of the volatility is derived from the market price of the market traded derivative. Volatility is a statistical measure which distributed returns for a given security or market index. The measurement process of volatility is can be done either by using standard deviation or variance between returns of that same security or market index. It is seen that when the volatility goes higher the risk of that investment simultaneously touches high ranks.

In other words, volatility is a variable option pricing formulas which exhibit the extension on which the return of the asset will differentiate from now than to the expiration of the option. Volatility is interpreted as a percentage that arises from the daily trading activities.

Books on Volatility

Book 1:

Modelling and Simulation of Stochastic Volatility in Finance By Christian Kahl (published by Universal-Publishers, 2008)

Book 2:

Derivatives in Financial Markets with Stochastic Volatility By Foque Jean-Peirre, George Papanicolaou, K. Ronnie Sircar (published by Cambridge University Press, 2000)

How Volatility works?

• In relative volatility, the measure of a particular stock would be interpreted as beta, which approximated the overall volatility of security’s returns depending on the returns of a relevant benchmark or index (such as the S&P 500).

• For example, suppose there is a stock that carries the beta value as 1.1, and historically moved from 110% per 100% against the benchmark, depending on the price level. On the reverse side, a stock which carries beta value as .9 has historically moved 90% for every 100% move against the market index or benchmark.

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