Dec 16, 2011

Volatility versus. Risk

The modern portfolio management necessarily lead to financial risk metrics. The concept of risk and volatility, however, are not fully understood, including the financial surrounding.

Risk is a possibility of financial loss. In the financial market through a few different types of risk such as operational risks (related to typical human failures) or the credit risk (mainly in debt securities), but the main risk is considered in the financial market risk. This risk is also known as volatility.

Volatility represents the level of fluctuation in the price of paper. If priced paper financial bounce, either up or down, an observed behavior in crisis, their volatility is so high.

Standard Deviation

This metric is obtained through statistical techniques, but can be understood intuitively. The standard deviation, which is a measure for dispersion is often used by the market to quantify market risk. This measure takes into account an assumption that the returns of the asset price analysis assumes a normal distribution.

Risk is Good or Bad?

Risk, by its very definition is unwanted because it is the representation of their financial loss. However, the volatility is not always undesirable since it is on account of it that makes it possible to profit by the financial investment or speculation.

It seems somewhat paradoxical to imagine two very interconnected which is an unwanted and the other is desirable. But if we imagine free market volatility, we cannot think of speculative gains.

Volatility is Good or Bad?

Volatility is a natural feature of financial markets and reflects the diverse interactions of market participants. For some volatility is undesirable, as on agribusiness who, while waiting to harvest and sale, assumes currency exposures, as the price of their commodities, interest rates, etc..
For qualified institutions to deal with the volatility as banks, investors and speculators volatility is desired, and often through the mechanisms of high leverage so they can generate more return possibilities.

Controlling the Risk!

Financial risk can be measured and mechanisms as well as the diversification of roles and help hedge in its control. The risk monitoring and simulation scenarios are indispensable tools for anyone who has exposed to financial market operations.

Rodrigo Sucupira Rodrigo Sucupira
Rodrigo is a Automation and Control Engineer - Escola Politécnica / USP. Interested on Financial Engineering, writes articles about Finance and Technology.
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