Volatility risk is the risk of a change of price of a portfolio as a result of changes in the
volatility of a risk factor. It usually applies to portfolios of derivatives instruments, where the volatility of its underlying is a major influencer of prices.
Sensitivity to volatility
A measure for the sensitivity of a price of a portfolio (or asset) to changes in volatility is
vega
Vega is the brightest star in the northern constellation of Lyra. It has the Bayer designation α Lyrae, which is Latinised to Alpha Lyrae and abbreviated Alpha Lyr or α Lyr. This star is relatively close at only from the Sun, a ...
, the rate of change of the value of the portfolio with respect to the
volatility of the underlying asset.
Risk management
This kind of risk can be managed using appropriate financial instruments whose price depends on the volatility of a given financial asset (a
stock
In finance, stock (also capital stock) consists of all the Share (finance), shares by which ownership of a corporation or company is divided.Longman Business English Dictionary: "stock - ''especially AmE'' one of the shares into which owners ...
, a
commodity
In economics, a commodity is an economic good, usually a resource, that has full or substantial fungibility: that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them.
The price of a co ...
, an
interest rate
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, th ...
, etc.). Examples are
Futures contracts such as
VIX
VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options. It is calculated and disseminated on ...
for equities, or
caps
Caps are flat headgear.
Caps or CAPS may also refer to:
Science and technology Computing
* CESG Assisted Products Service, provided by the U.K. Government Communications Headquarters
* Composite Application Platform Suite, by Java Caps, a Jav ...
,
floors
A floor is the bottom surface of a room or vehicle. Floors vary from simple dirt in a cave to many layered surfaces made with modern technology. Floors may be stone, wood, bamboo, metal or any other material that can support the expected load ...
and
swaptions
A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap. Although options can be traded on a variety of swaps, the term "swaption" typically refers to options on interest rate swaps.
Types of ...
for interest rates.
Risk management is the configuration and identification of analyzing, and or acceptance during
investment
Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort.
In finance, the purpose of investing is ...
decision-making. In essence this occurs whenever an investor or portfolio manager evaluates potential losses within an investment. Under certain investment objectives, appropriate solutions (or no solution) will occur to assess the investors goals and standards.
Improper risk management can and or will negatively affect companies as well as their individuals. For example, the
recession that began in 2008 was largely caused by the loose credit risk management of financial firms.
See also
*
Derivative
In mathematics, the derivative of a function of a real variable measures the sensitivity to change of the function value (output value) with respect to a change in its argument (input value). Derivatives are a fundamental tool of calculus. ...
*
Implied volatility In financial mathematics, the implied volatility (IV) of an option contract is that value of the volatility of the underlying instrument which, when input in an option pricing model (such as Black–Scholes), will return a theoretical value equ ...
*
Market risk
Market risk is the risk of losses in positions arising from movements in market variables like prices and volatility.
There is no unique classification as each classification may refer to different aspects of market risk. Nevertheless, the mos ...
*
Risk management
*
Standard deviation
In statistics, the standard deviation is a measure of the amount of variation or dispersion of a set of values. A low standard deviation indicates that the values tend to be close to the mean (also called the expected value) of the set, w ...
*
Value at risk
Value at risk (VaR) is a measure of the risk of loss for investments. It estimates how much a set of investments might lose (with a given probability), given normal market conditions, in a set time period such as a day. VaR is typically used by ...
method
*
Volatility risk premium
References
Financial risk
Market risk
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