VOLATILITY AND RISK

MEASURES

E K AT E R I N A VA K H R U S H E VA
B U R U I A N A TAT I A N A
SIMON ALINA
 WHAT IS VOLATILITY?

• Volatility - a statistical financial indicator, characterizing the

volatility of prices. It is an important financial indicator and
concept in the management of financial risks, where it
represents a measure of the risk of using a financial instrument
for a given period of time.
 Volatility is
expressed

In absolute In relative value from

value the initial value

100$
80%
 THERE ARE TWO TYPES OF
VOLATILITY:
• 1. Historical volatility
is a value equal to the standard deviation of the value of a

financial instrument for a given period of time, calculated on

the basis of historical data on its value.
• 2. Expected volatility-
volatility, calculated on the basis of the current value of a
financial instrument on the assumption that the market value of
a financial instrument reflects the expected risks.
 CALCULATION OF HISTORICAL
VOLATILITY:
The annual average volatility sigma σ is proportional to the standard deviation
σsd of the yield of a financial instrument and inversely proportional to the
square root of the time period:

𝜎𝑆𝐷
𝜎=
𝑝

where σsd is the standard deviation of the yield of the financial

instrument; P - time period in years.
•
For example, if the standard deviation of the yield of a financial
instrument during the day is 0.01, and in a year there are 252 trading
days (that is, the time period is 1 day = 1/252), then the average
annual volatility will be:

0.01
• 𝜎= =0.1587
1
252

•
The volatility for the month (T = 1/12 years) will be:
1
• 𝜎month=0.1587 =0.0458
12
THE EXPECTED VOLATILITY DEPENDS ON
THE FOLLOWING FACTORS:

from historical volatility - the higher it is at present,

the higher the expectations for future volatility;

from the political and economic situation (elections,

promulgation of economic indicators, etc.);

from liquidity (supply / demand) of the market - if the

supply exceeds demand, prices fall, and vice versa;

from the change of technical levels - when the

market regarded as an important level in the market
of historical price behavior is penetrated, the market
is waiting for further instability;
RISK !!!
WHAT IS RISK?
WHAT IS RISK? (2)

A Ship is very safe in a shore.

But, it is not meant for that.

A Ship has to sail by taking RISK.

Banking too is no exception.

A Bank has to carry Business

by taking (Informed & calculated) RISK
 WHAT IS RISK? (3)

• The threat that an event or action will adversely

affect an organization's ability to achieve its
business objectives and execute its strategies
successfully.
Commercial Banking PGP III Risk Management & Compliances 12
 SOURCES OF RISK
• Decision, Indecision • Political compulsions
• Business cycles/ • Regulations
Seasonality • Human resources,
• Economic/Fiscal skill sets
changes • Competition
• Policy Changes • Technology
• Market movements • Non-availability of
• Events information
 DIFFERENT TYPES OF RISKS
• Banks and Financial Institutions, in the process of
carrying their businesses, face various kinds of
financial and non-financial risks -
• Credit Risk
• Liquidity Risk
• Interest Rate Risk
• Market Risk
• Off-Balance Sheet Risk
• Foreign Exchange Risk
• Country or Sovereign Risk .................
 DIFFERENT TYPES OF RISKS (2)

• Operational Risk
• Technology Risk
• Compliance (Regulatory) Risk
• Legal Risk
• Reputation Risk
• Insolvency Risk
 INTER-DEPENDENCE OF RISKS

• These risks are highly interdependent and events

that affect each other

• One area of risk can have ramifications for a range

of other risk categories.
 RISK MEASUREMENT

• Uses Quantitative measures of Risk

• Seek to measure variations in Earnings, Market
value, Losses due to default, etc.
• Quantitative Measures used are :
• Sensitivity
• Volatility
• Downgrade potential
 RISK MEASURES

Risk measures are statistical measures that are historical predictors

of investment risk and volatility, and they are also major components
in modern portfolio theory (MPT).
MPT is a standard financial and academic methodology for
assessing the performance of a stock or a stock fund as compared to
its benchmark index.
 RISK MEASURES

There are five principal risk measures:

1. Alpha
2. Beta
3. R-Squared
4. Standard Deviation
5. Sharpe Ratio
 ALPHA
Alpha measures risk relative to the market or a
selected benchmark index.
 BETA

Beta measures the volatility or systemic risk of a

fund in comparison to the market or the selected
benchmark index.
 R-SQUARED
R-Squared measures the percentage of an
investment's movement that is attributable to
movements in its benchmark index.
STANDARD DEVIATION

Standard deviation is a method of measuring data

dispersion in regards to the mean value of the
dataset and provides a measurement regarding an
investment’s volatility.
 SHARPE RATIO

The Sharpe ratio measures performance as

adjusted by the associated risks.