Volatility Concept
Volatility is the variability of the return of a share with respect to its average in a given period of time. When that volatility is compared to market volatility, it is called .
Variable income does not expire and its yield is not known in advance, and its divestment is only possible with the sale of the asset. The great risk, then, of investing in equities is the “price risk”, the rest of the risks are included in it and are basically the following:
1. ‘Issuer’ risk. Probability that the company issuing the shares enters a bankruptcy and liquidation process, which, when detected by investors, massively sells the security, sinking the price. It breaks down into two risks:
– 1.1. Internal risks: Strategic management, production, financial solvency, etc.
– 1.2. External risks: From the economic environment, the sector, the political environment, etc.
2. Liquidity risk. It is the risk of not being able to divest at any time without sacrificing price.
‘Volatility’ is a way of measuring this ‘price risk’, surely the most widely used.
This variability can mean that if an investor wants to sell, they can do so below the purchase price and thus obtain a negative return.
The negative effect of volatility on a stock’s return tends to diminish over time. The term, contrary to what happens with fixed income, reduces the risk.
The volatility of a stock calculated based on historical data is the y coincides with the standard deviation of its continuous returns. The standard deviation is a statistical variable that, in this case, measures the degree of dispersion of the daily return with respect to the average return in that period.
In short, we can find the historical volatility of a stock, but we must bear in mind that we cannot infer that it will be exactly the same in the future… but it is helpful. The future volatility of a share is by definition unknown, the calculation of the historical volatility helps us to estimate it.
Volatility Types
– is the variability of the return (not the price) of a financial asset (in this case a share) in a period of time with respect to the average return in that period.
– It is the volatility that a certain financial asset is estimated to have in the future. It is also known as market volatility and is calculated from the price of assets at the current time. Therefore, the implied volatility will be the percentage of the implied volatility in the price of an asset when the rest of the factors (price of the underlying, strike price, dividends, interest rates, maturity time) that intervene in the calculation of the asset price are known. This type of volatility is not unique and shows the expectations of the market regarding volatility and, therefore, it may change depending on the agent that performs it. In addition, it is a measure of the uncertainty existing in the market and tends to reach higher values when the market shows a downward trend and lower values when the market shows a bullish trend.
Stochastic volatility – When the volatility of different assets changes over time in an uncertain way. To estimate this type of volatility, autoregressive conditional heteroskedasticity models or stochastic volatility models can be used.
Deterministic volatility – When there are no changes in volatility or if they do occur, they can be estimated without any measurement error. To estimate this type of volatility, the standard deviation of the data that makes up the series under study is used.
Xavier Puig. Doctor in Business Administration and Management and director of the Banking and Finance programs at UPF Barcelona School of Management.
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