Risk metrics
1. Risk metrics
The performance of a stock, like any other financial security, cannot be assessed only through reward indicators like the average return or the effective rate of return. The risk is another crucial component that characterizes the past performance.2. Volatility
The most commonly used risk metric among practitioners is the volatility of the stock returns. The volatility is simply the standard deviation of the returns, a statistical measure that quantifies the dispersion of the returns around their average.3. Volatility
The higher the volatility, the larger the amplitude of the past returns, and the riskier the stock.4. Volatility
Let's take an example. Given a series of four historical returns, where the average return is 0%, the volatility is the square root of the sum of squared deviations from the mean divided by the number of returns minus one. In this case 46%.5. Volatility with Google Sheets
To compute the volatility with spreadsheets, you can directly apply the formula. You are already familiar with all the functions that are needed here:6. Volatility with Google Sheets
AVERAGE(), to compute the average return.7. Volatility with Google Sheets
SUM(), to sum up the squared deviations of the historical returns from the average return,8. Volatility with Google Sheets
COUNT(), to count the number of returns to put in the denominator,9. Volatility with Google Sheets
and SQRT(), to compute the square root.10. Volatility with Google Sheets
Notice that you must use the ARRAYFORMULA() function here if you don't want to create any additional column.11. Function STDEV()
A quicker way to compute the volatility of stock returns is with the function STDEV(). It works like the other functions you've seen so far. You pass the range of cells containing the past returns as the main argument, and the function returns the value of the standard deviation, that is, the volatility of the historical returns.12. Historical value-at-risk (VaR)
Another indicator used to quantify the risk is the value-at-risk (VaR). While volatility captures the amplitude of price variations, the value-at-risk assesses major historical losses of your investment. Given a series of past returns, the historical value-at-risk is obtained as a low-level percentile of the returns.13. Intuition behind the value-at-risk
A percentile is a threshold value below which a given percentage of the past returns were observed. For example, the 5th percentile of historical returns is the value below which 5% of the returns were observed. It can be seen as a 5-percent worst-case scenario. This is the 5% historical value-at-risk.14. 5% Historical VaR with function PERCENTILE()
You can use the function PERCENTILE() to compute the historical value-at-risk.15. 5% Historical VaR with function PERCENTILE()
The first argument is the series of returns.16. 5% Historical VaR with function PERCENTILE()
The second argument is the level at which you want to measure the value-at-risk. For the 5% level, this is 0.05.17. It's time to practice!
Let's measure the monthly risk of stock ABC in the next exercises. Time to practice!Create Your Free Account
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