Variance

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# Variance - PowerPoint PPT Presentation

Variance. Expected squared deviation from the mean Standard Deviation: Square root of variance Most widely used measures of risk Can calculate from historical data Very easy to calculate in a spreadsheet Often expressed as annualized number. How to calculate variance.

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## PowerPoint Slideshow about 'Variance' - aleda

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Presentation Transcript
Variance
• Expected squared deviation from the mean
• Standard Deviation:
• Square root of variance

Most widely used measures of risk

• Can calculate from historical data
• Very easy to calculate in a spreadsheet
• Often expressed as annualized number
How to calculate variance
• Calculate returns each period
• Daily, Weekly, or Monthly
• Find the average return
• Sample mean, CAPM expected return, or Zero
• For each period, calculate difference between realized return and expected return
• Square them, sum, and divide by N-1
• Or, just use spreadsheet function VAR
How to calculate variance
• Alternative Formula
Calculating Standard Deviation
• Calculate Variance
• Take the Square Root
• Or use spreadsheet function STDEV
Annualize
• To annualize variance:
• For monthly data, multiply by 12
• For weekly data, multiply by 52
• For daily data, multiply by 252
• To annualize standard deviation
• Multiply by square root of 12, 52 or 252
Volatility
• The annualized standard deviation of returns is sometimes called “Volatility”
Drawbacks
• Variance does not give the whole picture
• Skewness may be important
• Variance treats large negative events the same as large positive ones
Scenario Analysis
• Specify hypothetical outcomes
• Assign probability distribution
• Example: Insurance company
• Example: Corporate bond