Investment volatilityLast updated on
Investment volatility is a measure of how risky a particular investment is, and it is used in the pricing of assets to gauge fluctuations in returns on investment. This simply means when the volatility is high, the trading risks are higher and vice versa. Investment volatility is further categorized into the following types.
1. Implied volatility: this reflects how the marketplace views where volatility should be in the future, but it does not forecast the direction that the asset’s price will move.
2. Historical Volatility: this is a statistical measure of the dispersion of returns for a given security or market index over a given period of time. The higher the Historical Volatility (HV) value, the more risky the investment.
Why is investment volatile?
The key lies in the nature of the investment process. Investment decisions often require long lead times, and their consequences are as durable as the investment goods themselves. Consider, for example, the case of commercial construction, which declined in the late eighties. Office buildings planned during a period of strong demand for space may be completed during a recession, when demand even for existing space is weak.
Such a shift in fortunes causes a decline in investment for two reasons. First, the need for office space has declined. Second, the amount of office space has risen, so that subsequent investment must fall not only to keep pace with slower demand, but also to eliminate the “overhang” of empty space.
In all, Investors can use volatility to help safeguard them from making irrational investment.