Market volatility and what to make of it are matters every investor wants to really understand so they will not be victims of losses and the ups and downs of the market or even the economy into which they are investing.
Let us consider, for instance, the market index or a given security. The statistical measure of the dispersion of returns given for these is called volatility and may either be measured using the variance or standard deviation between returns from the same market index or security. In practical terms the riskier the security, the higher the volatility.
Let’s look at it another way.
Option pricing formulas have a variable that shows the degree to which the underlying assets return fluctuates between the present and when the option expires. Volatility arises from the trading that goes on daily and is expressed as a percentage coefficient that is within the option-pricing formulas. The value of the coefficient used is affected by how volatility is measured.
In layman’s terms, the up and down movement of the market in just a number of days is what volatility is.
This simply indicates the fact that volatility refers to the degree of risk and uncertainty in the size of changes there are in a security’s value. A security’s value can is more likely to be spread out over a larger range of values if it has a higher volatility. Meaning that the security’s price is able to dramatically change in either direction over a short period of time. But if the security has a lower volatility, its value would change at a steady pace over a given period of time but wouldn’t fluctuate dramatically.
Impacts of volatility on economy and market returns
A very strong relationship exists between market performance and market volatility and this relationship is a really strong factor. Volatility increases or decreases with the corresponding fall or rise in the market. When volatility index increases, risks, and returns decrease. In 2011, a research was conducted using the Standard & Poor’s 500 Index to examine the relationship between volatility and the performance of the stock market. According to the findings of the research, a higher probability of the market declining will result from a corresponding high volatility while if the volatility is low, there will be a greater possibility of an increase in the market.
The average daily range in the index or the first quartile was shown by the research to be as low between 0% and 1%, the investors’ gain of 1.5% monthly and 14.5% yearly were probably resulting in a monthly odd of 70% and a 91% annual odd. It was established by the research that the impact risk had in relation to market volatility stayed constant across the market movements’ entire spectrum when the fourth quartile range was found to be between 1.9% and 5% and this resulted in a possible 0.8% loss monthly and a yearly loss of 5.1%.
Factors Affecting Market Volatility
The volatility index of the market is affected by several factors. Among the factors, the major ones are national and regional economic factors like interest rates policies, major economic policy announcements, tax rates revisions, consumer price index data, inflation data, housing market data, unemployment data, producer price index data and others like this. When the short-term index for borrowing by banks (known normally as overnight rates) is changed by a country’s central bank, there is a significant or maybe even violent reaction to this by the stock market. Inflation will, similarly, remain stable and low or decline when the price-earnings ratios (P/E ratios) expand. Market volatility in such situations will be low and trend higher. On the other hand, when due to rising or higher inflation the P/E ratios fall, the prices will be unstable and this will lead to a fall in the markets and higher volatility index.
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