Volatility
Potential definitions:
- Volatility is a basic process which complements a trigger mechanism.
- A situation is volatile if it is ready to change, just waiting for something to set it off.
- Volatility can refer to unstable situations subject to rapid and frequent change.
- an explosive mixture of a volatile liquid and air.
- the stock market in a time of uncertainty.
To fix ideas, imagine that over the relevant period, a given asset has never returned more than 20% in a financial quarter on any dollar invested. Over the same period, the worst performance is a loss of 5% of the dollar.
In such a situation, a full plot of the returns by quarter would generally take the shape of the famous bell curve, or normal distribution. The 20% gain would be one "tail" of that curve. The 5% loss would be the other tail. Some result in between (perhaps 7% gain) would be the mean asset return.
The "standard deviation" measures the width of the central hump of such a bell curve. That is also called the "volatility" of that asset because by definition the higher the number, the more wildly results may vary from quarter to quarter.
The volatility of an asset is crucial in the determination of the value of any future claim upon that asset.