February 14th, 2006, 8:39 pm
Volatility is the measure of how much a price of an asset has changed over time. Usually, volatility is indicated by a summary statistic of some sort, like a moving average or a standard deviation, because we assume that many observations give more information than one observation. The most common measure of volatility is the standard deviation of the closing prices over a year. When you read an asset has a volatility of 16%, it means that the standard deviation of the prices in the last year was 16%. There are many other ways to calculate the volatility of an asset, but the central concept is that volatility is the amount of change in the price of the asset over a period of time. Here are the names of some other methods of calculating and measuring volatility:Garman-KlassParkinsonAverage True RangeBetaVolatility is the most common measure of risk in trading. We make a differentiation between historical and implied volatility. Historical volatility is calculated from historical prices or information, as explained above.Implied volatility is calculated as the output of an options pricing model. In a standard options pricing model, you need a volatility to calculate the price of an option. If you know this volatility, you can calculate a price. However, you are holding the option over a period of future time, and therefore the volatility of the asset is not known. As a result, traders make guesses about the future volatility of this asset, some better than others. This market creates a price for the option, and with that price, you can then calculate the volatility associated with that option price. This is known as the implied volatility.