Editing Volatility risk

{{Financial risk types}}
'''Volatility risk''' is [[financial risk|the risk of]] an adverse change of price, due to changes in the [[volatility (finance)|volatility]] of a [[risk factor (finance)|factor affecting that price]]. It usually applies to [[derivative (finance)|derivative instruments]], and their portfolios, where the volatility of the [[Underlying|underlying asset]] is a [[Valuation_of_options#Other_factors_affecting_premium|major influencer]] of [[option pricing|option prices]].<ref name="Brenner et al">[[Menachem Brenner]], Ernest Y. Ou, Jin E. Zhang (2006). [https://pages.stern.nyu.edu/~mbrenner/research/HV_paper_in_JBF.pdf "Hedging volatility risk"]. ''Journal of Banking & Finance'' 30 (2006) 811–821</ref> It is also relevant to portfolios of basic assets, and to foreign currency trading.<ref name="Brenner et al" />

Volatility risk [[financial risk management|can be managed]] by [[hedge (finance)|hedging]] with appropriate [[financial instrument]]s.<ref name="AvellanedaParas">{{Cite journal |last1=Avellaneda |first1=M. |last2=Levy |first2=A. |last3=Parás |first3=A. |year=1995 |title=Pricing and hedging derivative securities in markets with uncertain volatilities |journal=Applied Mathematical Finance |volume=2 |issue=2 |pages=73–88 |doi=10.1080/13504869500000005}}</ref> These are [[volatility swap]]s, [[variance swap]]s, [[conditional variance swap]]s, [[Option on realized variance|variance options]], [[VIX]] [[futures contract|futures]] for equities, and (with some construction) [[Interest rate cap and floor|caps]], [[Interest rate cap and floor|floors]] and [[swaptions]] for interest rates.<ref>{{Cite book |last=Neftci |first=Salih N. |url=https://books.google.com/books?id=TB8ZIFDlKSwC&dq=finance+vega+volatility&pg=PA430 |title=Principles of Financial Engineering |publisher=Academic Press |year=2004 |isbn=978-0-12-515394-2 |series=Academic Press Advanced Finance Series |location=San Diego, CA and London |pages=430–431 |language=en |authorlink=Salih Neftci}}</ref><ref>{{Cite book |last1=Xekalaki |first1=Evdokia |url=https://books.google.com/books?id=_FZHKyuXOEwC&dq=vix+volatility+index&pg=PA342 |title=ARCH Models for Financial Applications |last2=Degiannakis |first2=Stavros |publisher=John Wiley & Sons |year=2010 |isbn=978-0-470-68802-1 |location=Chichester, UK |pages=341–343 |language=en}}</ref><ref>Andrew Lesniewski (2015). [https://mfe.baruch.cuny.edu/wp-content/uploads/2015/06/VolWork6-Andrew.pdf Managing interest rate volatility risk]</ref> Here, the hedge-instrument is sensitive to the same source of volatility as the asset being protected (i.e. the same [[stock]], [[commodity]], or [[interest rate]] etc.). The position is then established such that a change in the value of the protected-asset, is offset by a change in value of the hedge-instrument. The number of hedge-instruments purchased, will be [[Option_(finance)#Risks|a function of]] the relative sensitivity to volatility of the two: the measure of sensitivity is [[Greeks_(finance)#Vega|''vega'']], the rate of change of the value of the option, or option-portfolio, with respect to the volatility of the underlying asset.<ref>{{Cite book |last=Ploeg |first=Antoine Petrus Cornelius van der |url=https://books.google.com/books?id=yP0UwMU1RvUC&dq=finance+vega+volatility&pg=PA25 |title=Stochastic Volatility and the Pricing of Financial Derivatives |publisher=Rozenberg Publishers |year=2006 |isbn=978-90-5170-577-5 |series=Tinbergen Institute Research Series |location=Amsterdam, Netherlands |pages=25–26 |language=en}}</ref><ref>{{Cite book |last=Huang |first=Declan Chih-Yen |title=Forecasting Volatility in the Financial Markets |publisher=Butterworth-Heinemann |year=2002 |isbn=978-0-7506-5515-6 |editor-last=Knight |editor-first=John L. |series=Butterworth - Heinemann Finance |location=Oxford and Woburn, MA |pages=375–376 |language=en |chapter=The Information Content of the FTSE100 Index Option Implied Volatility and Its Structural Changes With Links to Loss Aversion |orig-year=1998 |editor-last2=Satchell |editor-first2=Stephen |chapter-url=https://books.google.com/books?id=pc3K-nVn09wC&dq=finance+vega+volatility&pg=PA376}}</ref>

Option traders often seek to create "vega neutral" positions, typically as part of an [[Options strategy|options trading strategy]].<ref>See, e.g., [https://www.macroption.com/vega-neutral-option-strategies/ Vega Neutral Option Strategies]</ref> The value of an at-the-money [[straddle]], for example, is extremely dependent on changes to volatility. Here the total vega of the position is (near) zero — i.e. the impact of [[implied volatility]] is negated — allowing the trader to gain exposure to the specific opportunity, without concern for changing volatility.{{Citation needed|date=March 2025|reason=unclear in what context the 'here' refers to}}

==See also==
*[[Financial risk management]]
*[[Implied volatility]]
**[[Volatility smile]]
**[[IVX]]
*[[Market risk]]
*{{slink|Model risk#Uncertainty on volatility}}
*[[Value at risk]]
*[[Volatility beta]]
*[[Volatility risk premium]]

==References==
{{Reflist}}
{{Financial risk}}

{{DEFAULTSORT:Volatility Risk}}
[[Category:Financial risk]]
[[Category:Market risk]]
[[Category:Financial risk modeling]]
[[Category:Options_(finance)]]
[[Category:Derivatives_(finance)]]
{{Investment-stub}}

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[[Risk management]] is the configuration and identification of analyzing, and or acceptance during [[investment]] decision-making. In essence this occurs whenever an investor or portfolio manager evaluates potential losses within an investment. Under certain investment objectives, appropriate solutions (or no solution) will occur to assess the investors goals and standards.<ref>{{Cite book|chapter-url=https://books.google.com/books?id=7LOD1CmBD-cC&dq=vix+volatility+index&pg=PA198|title=Handbook of Finance, Financial Markets and Instruments|last=Whaley|first=Robert|publisher=John Wiley & Sons|year=2008|isbn=978-0-470-39107-5|editor-last=Fabozzi|editor-first=Frank J.|location=Hoboken, NJ|pages=193–194|language=en|chapter=Volatility Derivatives}}</ref>
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Improper risk management can and or will negatively affect companies as well as their individuals. For example, the [[Financial crisis of 2007–08|recession that began in 2008]] was largely caused by the loose credit risk management of financial firms.<ref>{{Cite book|url=https://books.google.com/books?id=Rr_6y9evvowC&q=financial+crisis+2008+credit+risk+management|title=Credit Risk Management In and Out of the Financial Crisis: New Approaches to Value at Risk and Other Paradigms|last1=Saunders|first1=Anthony|last2=Allen|first2=Linda|publisher=John Wiley & Sons|year=2010|isbn=978-0-470-62236-0|location=Hoboken, NJ|pages=3–4|language=en}}</ref><ref>{{Cite journal|last1=Mačerinskienė|first1=Irena|last2=Ivaškevičiūtė|first2=Laura|last3=Railienė|first3=Ginta|date=2014|title=The Financial Crisis Impact on Credit Risk Management in Commercial Banks|journal=KSI Transactions on KNOWLEDGE SOCIETY|volume=7|issue=1|pages=5–15|s2cid=53977152}}</ref> 
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