Moreover, it is not just price gyrations that have increased, but the
volatility of volatility itself. The markets, it seems, now have an
added dimension of risk."
Call-writing has soared as punters, fund managers, and institutional
investors try to eke an extra return out of the wild ride and to
protect their dwindling equity portfolios. Naked strategies - selling
options contracts or buying them in the absence of an investment
portfolio of underlying assets - translate into the trading of
volatility itself and, hence, of risk. Short-selling and spread-betting
funds join single stock futures in profiting from the downside.
Market - also known as beta or systematic - risk and volatility reflect
underlying problems with the economy as a whole and with corporate
governance: lack of transparency, bad loans, default rates,
uncertainty, illiquidity, external shocks, and other negative
externalities. The behavior of a specific security reveals additional,
idiosyncratic, risks, known as alpha.
Quantifying volatility has yielded an equal number of Nobel prizes and
controversies. The vacillation of security prices is often measured by
a coefficient of variation within the Black-Scholes formula published
in 1973.
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