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Volatility

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In finance, volatility is a statistical measure of the tendency of a security's price to change over time. Volatility is defined as the standard deviation of the return over time T. (For technical reasons, volatility is usually computed based on log return rather than return.) Volatility must be stated for a specific period of time, such as a day or a year. Implied volatility is the volatility suggested for the price of an underlying asset based on the price of an option on that underlying. Implied volatility is obtained by solving an option pricing formula such as Black-Scholes for the volatility variable using the current option price. Ordinarily, an option pricing model is used to price an option, using historical volatility. Thus a difference between implied volatility and historical volatility suggests that market participants believe a security's performance will be different from past performance.



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