Question

explain the relationship between the changes of volatility and the required rate of retun for the stock. The correlation between both variables are -0.46 (200 words)

Answer 1

Volatility is a measure of dispersion around mean or it tells us how much the price of a stock is moving around its mean measured by the standard deviation. When the prices are tightly stuck together, the standard deviation is low and so is the volatility. The higher the standard deviation, the greater the dispersion of returns, and thus the higher the risks associated with the investment. So, when there is the larger volatility in the prices of the stock or simply the higher risks about the returns, the investors would want to have higher returns to get compensated for the higher risks they would take by investing. Or we can say that the volatility of stock returns requires a risk premium as explained above. The risk premium and the volatility have a positive relationship between them while there is thus a negative relationship between the volatility and the required rate of return for the stock. The negative correlation coefficient also indicates that there is a negative relationship between volatility and the required rate of return and the value of -0.46 imply a moderate relationship.