Volatility

What is volatility?

The dictionary definition of volatility is the liability to change rapidly and unpredictably.

When applied to finance, we normally talk about volatility with respect to the price of an asset. In this sense, volatility is a measure of how unpredictable an asset's price changes are. Volatility is therefore used as a measure of risk: the higher the volatility of an asset's returns, the more unpredictable they are, and hence the riskier that asset is perceived to be.

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What you need to know:

  • Volatility is a measure of how unpredictable an asset's price changes are.
  • When calculating volatility, remember you are calculating the historical volatility, and it's not necessarily true that the historical volatility will continue into the future.

We can define volatility in more statistical terms as a measure of the dispersion of returns for an asset. It is conventionally calculated as the standard deviation of those returns over a given period.

A very important point however is that while we calculate volatility using an asset's prices, this means we are calculating the historical volatility, and it's not necessarily true that the historical volatility will continue into the future.