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Paathshaala : Volatility

Volatility

Volatility most frequently refers to the standard deviation of the change in value of a financial instrument with a specific time horizon. It is often used to quantify the risk of the instrument over that time period. Volatility is typically expressed in annualized terms, and it may either be an absolute number ($5) or a fraction of the initial value (5%).

For a financial instrument, the volatility increases by the square-root of time as time increases. Conceptually, this is because there is an increasing probability that the instrument's price will be farther away from the initial price as time increases.

Historical volatility is the standard deviation of a financial instrument based on historical returns. This phrase is used particularly when it is wished to distinguish between the actual volatility of an instrument in the past, and the current volatility implied by the market.

Volatility of returns of a fund is measured by standard deviation which is a measure of total risk of a fund. Volatility indicates the tendency of the funds NAV (Net Asset Value) to rise and fall in a short period. It measures the extent to which the NAV fluctuates as compared to the average returns during a period.

A fund that has a consistent four year return of 3 %, for example, would have a mean , or average, of 3 %. The standard deviation for this fund would then be zero because the fund’s return in any given year does not differ from its four year mean of 3 %. On the other hand, a fund that in each of the last four years returned -5%, 17%, 2% and 30% will have a mean return of 11%.The fund will also exhibit a high standard deviation because each year the return of the fund differs from mean return. This fund is therefore more risky because it fluctuates widely between negative and positive returns within a short period.

A higher standard Deviation means that the returns of the fund have been more volatile than a fund having low standard deviation. In other words high standard deviation means high risk.


 
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