How is volatility related to risk?

Volatility is a statistical measure of the dispersion of returns for a given security or market index, and it provides insight into the level of uncertainty or risk associated with the price movements of an asset. When volatility is high, it indicates that the price of the asset can fluctuate widely over a short period of time. This uncertainty makes the asset riskier for investors, as the potential for significant gains is accompanied by the possibility of substantial losses.

Higher volatility can lead to larger price swings, which may pose a greater risk for investors looking for stable returns. Therefore, recognizing that higher volatility reflects greater uncertainty about the future price of an asset is key to understanding why it is associated with higher risk. This relationship is crucial for risk management and investment decision-making, as it affects portfolio construction and the assessment of potential returns versus potential losses.

The other choices suggest alternative views that do not accurately reflect the inherent relationship between volatility and risk in financial contexts. For instance, stating that higher volatility indicates lower risk contradicts the fundamental understanding of risk as it relates to unpredictability in asset returns. Similarly, claiming that volatility has no relation to risk overlooks the importance of volatility as a key measure of uncertainty in financial markets, and suggesting that volatility measures only market liquidity disregards its broader