Using Historical Volatility To Gauge Future Risk

Volatility is critical to risk measurement. Generally, volatility refers to standard deviation, which is a dispersion measure. Greater dispersion implies greater risk, which implies higher odds of a price erosion or portfolio loss - this is key information for any investor. Volatility can be used on its own, as in "the hedge fund portfolio exhibited a monthly volatility of 5%," but the term is also used in conjunction with return measures, as, for example, in the denominator of the Sharpe ratio. Volatility is also a key input in parametric value at risk (VAR), where portfolio exposure is a function of volatility. In this article, we'll show you how calculate historical volatility to determine the future risk of your investments. (For more insight, read The Uses And Limits Of Volatility.)