Reply to the discussion board post
Thank you for your post. You provided a good definition of such concept as volatility and described its uses by analysts and risk managers. Yet, there are many other issues which should be discussed in connection with this notion. First, it should be mentioned that volatility is essentially the measure of variability or fluctuations rather than the direction of the price (Shamah, 2004, p 59). In other words, volatility measurements can show to what extant stock prices can fluctuate in the foreseeable future, but they cannot tell whether the value of these stocks will grow or decline in the long term.
Apart from that, many scholars criticize existing volatility forecasting models for the inability to take into account all hypothetical risks (Goldstein & Taleb, 2007). In other words, existing mathematical models cannot fully identify the factors which cause volatility of prices. For example, such index as Nikkei 225 declined by more than 16 percent within a week after Tohoku earthquake (Reuters, 2011, unpaged). Modern fluctuation forecasting models cannot predict such an event or accurately determine its impact. Hence, one can argue that volatility measurements cannot always be effective risk assessment tools. Furthermore, it is necessary to take into consideration that there are many different models of estimating volatility; they can be parametric, non-parametric, linear, or non-linear (Brooks, 2008, p 420; Valdez, 2010).
At the given moment, their effectiveness and accuracy are still disputed by scholars and researchers. Overall, it is possible to view price variations as a dependent variable; yet, it is rather difficult to identify the independent ones. In other words, one still has to determine what kind of factors can affect the value of stocks or currency and to what extent. Among them one can single out such variables as the policies of the company or companies, their financial performance, market position, products, and so forth. This information is not always publicly available. Such forecasting models can be fully efficient only in the market in which past and present data about the stocks are readily accessible to the public. Volatility measurements tools can describe price variations within a certain period of time but they can always tell what caused it or what will cause it. These are the main limitations of these tools, especially for a person who wants to make a considerable and long-term investment into the stocks of a certain company.
However, one should not suppose that volatility is some negative phenomenon. George Fontanilis and Tom Gentile argue that fluctuations of prices are inevitable in financial markets and volatility forecasting models can allow a person to profit in spite of market direction (2002, p 3). The measurement and analysis of price variations can tell when it is necessary to purchase stocks or when one has to sell them. They are more suitable for traders rather than those people who want to make a long-term investment. These techniques can be particularly useful when one has to sell stocks at a particular date in the future. If volatility is very high there is a great likelihood that a trader will incur great losses, and vice versa, low degree of price variation indicates that the risks are less significant. These are the issues that one should consider while evaluating the efficiency of volatility measurement as forecasting or risk assessment tools.
Again, thank you for your discussion post. Hopefully, my comments will be of some use to you.
Reference List
Brooks C. (2008). Introductory Econometrics for Finance. Cambridge: Cambridge University Press.
Fontanilis G. & Gentile T. (2002). The Volatility Course Workbook: Step-By-Step Exercises to Help You Master the Volatility Course. NY: John Wiley and Sons.
Goldstein D. & Taleb N. (2007). We Don’t Quite Know What We Are Talking About When We Talk About Volatility.Journal of Portfolio Management. 33, (4), 3-11 2007. Web.
Reuters. (2011). “Japan earthquake: market reaction”. Web.
Shamah S. (2004). A currency options primer. NY: John Wiley and Sons.
Valdez, S. (2010). An Introduction To Global Financial Markets. (6th Ed). New York: Palgrave Macmillan.