Financial Risk Manager Part 1

Explanation

Historical volatility and implied volatility are two different measures used to understand the price movements of an asset:

Historical Volatility

• Measures the standard deviation of past price movements
• Based on historical data
• Quantifies the variation or dispersion of an asset's prices in the past
• Backward-looking measure

Implied Volatility

• Gives an estimate of future volatility in the price of the asset
• Forward-looking measure
• Derived from the price of an option using models like Black-Scholes
• Reflects the market's expectation of future volatility
• Does not predict the direction of future price movements, only the magnitude

Why Other Options Are Incorrect:

• Option B: Incorrect because implied volatility is measurable using option pricing models
• Option C: Incorrect because historical volatility refers to past price movements, not present recorded volatility
• Option D: Incorrect because implied volatility provides future expectations, not historical measures beyond benchmarks

Implied volatility is particularly important in options trading as it helps determine option premiums and market expectations about future price fluctuations.