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Volatility

Volatility is a measure of risk. It represents the amplitude of variations of a financial asset.

The more volatile the underlying asset, the greater the probability that the price of this asset will reach extreme price levels - favorable or unfavorable -. More risk means better potential return: this is the risk premium. The volatility of stocks is on average between 20 and 50%.

Volatility is expressed as a percentage. To simplify, and without taking into account the time horizon, if the volatility of an asset is 5%, the price will vary between -5% and +5% of the average price of the underlying.

There are two ways to measure volatility:

  • Historical volatility is based on the observation of past data and corresponds to the calculation of the standard deviation - the measure of the dispersion of values ​​- of daily variations.
  • Implied volatility is based on the prices of derivatives of the financial asset. It represents the anticipations made by traders about future variations. Three factors influence this volatility: the price of the option, its maturity and the level of the risk-free rate. Its calculation is based on the Black & Scholes model and the Newton-Raphson algorithm.

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