Volatility risk

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Volatility risk is the risk of a change of price of a portfolio as a result of changes in the volatility of a risk factor. It usually applies to portfolios of derivatives instruments, where the volatility of its underlyings is a major influencer of prices.

Sensitivity to Volatility[edit]

A measure for the sensitivity of a price of a portfolio (or asset) to changes in volatility is vega, the rate of change of the value of the portfolio with respect to the volatility of the underlying asset.[1]

Risk Management[edit]

This kind of risk can be managed using appropriate financial instruments whose price depends on the volatility of a given financial asset (a stock, a commodity, an interest rate, etc.). Examples are Futures contracts such as VIX[2] for equities, or caps, floors and swaptions for interest rates.

References[edit]

  1. ^ Hull, Options, Futures and Other Derivatives, Sixth Edition, p360
  2. ^ http://www.cboe.com/micro/VIX/vixintro.aspx

See also[edit]