What is Volatility?

What is volatility?

We associate volatility with the magnitude of movements in the price, or percentage changes, of an asset over time. Assets with a high volatility have the potential to move a lot and low volatility, not so much.

The market convention is to define volatility as one standard deviation of annual returns measured as a percentage. For example, a fifteen percent volatility in very simplistic terms means about sixty eight percent of the time, that’s the one standard deviation bit, the return should be between plus and minus fifteen percent from its current level in a year.

What are the four types of volatility?

There are a number of types of volatility you might have come across:

1. Historic volatility: the standard deviation of past returns
2. Future volatility: we could always assume it will be the same as historic. But we’ve all heard the disclaimer, past performance is not necessarily a guide to future performance
3. Realised volatility: the difference between expected and realised volatility
4. Implied volatility: the market’s perception of future volatility and is obtained from the options markets. In fact when we refer to volatility, this is the version that we mostly refer to