Risk and Volatility - Same Thing?
I have heard my teachers again and again explain to my class that volatility and risk are the same thing, but from the methodologies of Graham and Dodd they are not? Can anyone help answer the question of who's right and who's wrong?
Volatility does not equal risk and you don't need to invoke Graham and Dodd to illustrate this point. Imagine you hold T-Bills and sell a bunch of way out of the money 1 month options on some stock or index. The volatility of that 'portfolio will be pretty low (in most months you make a tiny amount of money), but the possibility of permanent capital impairment is real.
Another problem is what "volatility" are they referring to and over what time frame? A problem with equating volatility and risk is that it is usually assumed that the distribution of returns are normal, which is clearly not true.
That being said, for the purposes of your class, just go with what they say to get a good grade.
Ideally, risk in financial terms is covariance with your marginal utility of consumption. Depending on how you extend that, you can imperfectly proxy for that with beta or volatility or a number of measures... all are flawed.
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