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

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.

Risk Management

This kind of risk can be managed using appropriate financial instruments whose price depends on the volatility of a given financial asset (a stock

Stock

The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...

, a commodity

Commodity

In economics, a commodity is the generic term for any marketable item produced to satisfy wants or needs. Economic commodities comprise goods and services....

, an interest rate

Interest rate

An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...

, etc.). Examples are Futures

Futures

-Finance:*Futures contract, a tradable financial contract*Futures exchange, a financial market where futures contracts are traded*Futures , an American finance magazine-Music:*Futures , a 2004 release by Jimmy Eat World...

 contracts such as ViX for equities, or caps

Interest rate cap and floor

An interest rate cap is a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price...

, floors

Interest rate cap and floor

An interest rate cap is a derivative in which the buyer receives payments at the end of each period in which the interest rate exceeds the agreed strike price...

 and swaptions for interest rates.

See also

• Derivative
  Derivative
  In calculus, a branch of mathematics, the derivative is a measure of how a function changes as its input changes. Loosely speaking, a derivative can be thought of as how much one quantity is changing in response to changes in some other quantity; for example, the derivative of the position of a...
  
  
• Market risk
  Market risk
  Market risk is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices...
  
  
• Standard deviation
  Standard deviation
  Standard deviation is a widely used measure of variability or diversity used in statistics and probability theory. It shows how much variation or "dispersion" there is from the average...
  
  
• Risk management
  Risk management
  Risk management is the identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities...
  
  
• Value at risk
  Value at risk
  In financial mathematics and financial risk management, Value at Risk is a widely used risk measure of the risk of loss on a specific portfolio of financial assets...
  
  method