Measuring Volatility
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Measuring Volatility
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Glossary
Mean Standard Deviation VolatilityTranscript
Here are two securities with their daily returns over a week. Security A, looks like it has the bigger price changes than Security B. Since the range of outcomes for A, is between minus three and plus 5% but only between minus one and plus 3% for Security B. How much the price of an equity security changes by is called volatility. And the volatility of an equity security, is a measure of its market risk. The normal way to measure volatility is by measuring the standard deviation of returns. This is because, if we simply measure the average distance from the mean, this will equal zero. The mean is the average and takes into account all the differences when it's calculated. Standard deviation is calculated by squaring the differences from the mean, adding them up for each data point, divided by the number of data points, and then taking a square root. This gives 2.8% for Security A and 1.4% for Security B. This shows that A, has more volatility, more market risk and it confirms our initial impression.