# Volatility and Risk

Can someone please tell me what’s the difference between volatility and risk? thx.

Since no one took this one, here is my take: One cannot compare Volatility and Risk. Just like we have Interest-Rate risk, credit risk, we also have something called Volatility Risk. Volatility : Tendency for unexpected changes in something, say prices, yields etc. Risk : What is at stake due to some factor, like volatility. For e.g.: If I buy a stock @20\$ and hold it expecting the price to rise to say 25\$, I am exposed to some volatility and hence some risk (maybe the stock will drop by 5\$?). In fact, if there is no volatility, there might be no reward. For e.g. zero volatility would nullify value of options. Things are a bit different with coupon bonds. Here we get steady (hopefully) payments. So, zero-volatility spread (ZVol) is calculated as a measure to understand the value of a bond in the absence of volatility compared against some other investment (say Tsy).

on the other hand, in day to day finance, risk is often made synonomous with vol. we often say, the stock is risky. sure, we may mean the company is garbage b/c they sell one commoditized product, but often we mean risky as in “the stock moves around a lot” so while the above answer is CORRECT, risk is basically “uncertainty of outcomes” and that on your average day, you can equate risk with volatility. dont forget that vol = st dev = sq rt of variance…

Volatility is often taken as a measure of “total” risk (i.e. total uncertainty in outcomes). This captures the effects fo all other forms of risk (i.e. beta measures systematic risk, or the firm’s exposure to market fluctuations, creadit risk is the risk due to adverse credit events, etc…). But in common usage, daj is correct - volatility and risk are very closely related.

volatility is a very convenient measure of risk because it can be easily calculated and aggregated for portfolios. therefore, it’s a good choice of risk measure when distributions are close to normal. however, when distributions are strongly non-normal with very fat tails (for example, option prices), volatility is a horrible measure of risk.

Posted by: maratikus (IP Logged) [hide posts from this user] Date: September 29, 2008 09:33AM however, when distributions are strongly non-normal with very fat tails (for example, option prices), volatility is a horrible measure of risk. DUDE!!! VOLATILITY is what causes option prices to fluctuate… it’s not a horrible measure of risk as you put it above… it’s an important way to measure the value of options… the more volatile the security… the more valuable the option price!!!

dudeinthecity Wrote: ------------------------------------------------------- > Posted by: maratikus (IP Logged) > Date: September 29, 2008 09:33AM > > > however, when distributions are strongly > non-normal with very fat tails (for example, > option prices), volatility is a horrible measure > of risk. > > DUDE!!! > > VOLATILITY is what causes option prices to > fluctuate… it’s not a horrible measure of risk > as you put it above… it’s an important way to > measure the value of options… > > the more volatile the security… the more > valuable the option price!!! We are talking about different volatility. You are talking about implied volatility and its relationship with the underlying instrument volatility, i.e. the higher underlying volatility, the higher the options premium. I’m talking about volatility of an option position as a measure of risk since in this thread we are talking a position volatility as its measure of risk.

Actually, not even worth addressing that one. Get a clue, dudeinthecity.

I’m talking about volatility of an option position as a measure of risk I dont understand…? can you explain it! I am sorry JOEYDvivre… WE all can’t be as smart as you.

overall, vol - bad for common vol - good for options, puts and calls. no need to throw punches guys. joey already has the CFA so while he trying to help, you must understand he has been on this board for almost 2 years

That makes sense and is way more constructive than Mr. CFA’s response. Thanks man!

daj224 Wrote: ------------------------------------------------------- > overall, > > vol - bad for common > vol - good for options, puts and calls. that’s irrelevant to the conversation on volatility as a measure of risk

Re: Volatility and Risk new Posted by: maratikus (IP Logged) [hide posts from this user] Date: September 29, 2008 02:18PM daj224 Wrote: ------------------------------------------------------- > overall, > > vol - bad for common > vol - good for options, puts and calls. that’s irrelevant to the conversation on volatility as a measure of risk EXPLAIN THEN!!!

Actually, vol might be good for common depending on what you mean. If you think of equity as a call on the assets of the company, then asset vol is certainly good for equity.

is there a straight answer to this question…? Example ME : Yes volatility = RISK!!!

The straight up answer is no they are not the same because either a) technically they are different or b) in the usual vernacular risk is broader than volatility. For a), Risk = Expectation(loss) while volatility = standard deviation of return. That means they are just different, although it’s pretty easy to see that in most situations you would think that expectation of loss would increase when volatility of returns increases. Any assumption like normality gives you that. For b), Risk is some vague statement about possible returns and what could go wrong. For example, “There is significant default risk in Goldman bonds right now” might have something to do with volatility, but it’s mostly a statement about a future bad event.

Thank you all for helping with this. Joe I agree largely with what you said on your last post. Just to add on that and correct me if i’m wrong: Standard deviation is not a true representation of risk, of course it does represent the dispersion of return, but it does not tell us in which direction those retuns deviate from the mean. Instead I believe semi-deviation taking the expected retun as the target is a better representation of the risk. The same thing as above can be said for volatility. For example on period t a price can move up and move up and up, although volatility in this case will be high it does not represent absolute risk.

Looks good though I would say that volatility = std. dev.

Giristide Wrote: ------------------------------------------------------- > Thank you all for helping with this. > > Joe I agree largely with what you said on your > last post. Just to add on that and correct me if > i’m wrong: > > Standard deviation is not a true representation of > risk, of course it does represent the dispersion > of return, but it does not tell us in which > direction those retuns deviate from the mean. > Instead I believe semi-deviation taking the > expected retun as the target is a better > representation of the risk. > > The same thing as above can be said for > volatility. For example on period t a price can > move up and move up and up, although volatility in > this case will be high it does not represent > absolute risk. You are correct about one of the problems with using standard deviation as a measure of risk. Indeed intuitively presense of large positive returns should somehow reduce risk but on the contrary large positive returns increase standard deviation. However, you still should be careful when you define risk because as a very subjective concepts risk has many definitions that have their own strengths and weaknesses and are appropriate for different situations. For example, standard deviation is a measure of risk. Strengths: easy to calculate, easy to aggregate for portfolios. Weaknesses: pretty much works well only for instruments that have normal distribution.