Volatility is one of the main features of the financial market, playing a significant role in managing portfolio, pricing of options and market conventions Poon and Granger, 2003. Volatility, in its simplest form, refers to the variation in the price of a stock. Volatility of a security market is determined by the variation in the price over a period of time, calculated as the standard deviation of the market returns. The higher the standard deviation, the higher the asset volatility is. An awareness of volatility in stock markets is therefore essential for finding out the cost of capital and for assessing investment and leverage decisions as volatility is identical to risk. Considerable shifts in volatility of financial can have major negative effects on risk averse investors.
Stock returns volatility varies considerably across global and have received a great consideration from researchers over past years since it can be utilized as a means to calculate risk in financial markets. Instability of stock returns has been a topic of interest in financial literature since long. A broad range of research has been carried out on stock returns volatility in both advanced and developing markets since 1970s. Financial economists are also curious about the sources as well as the inconsistencies relating to market volatility.
2.1 Theoretical Review
The variations in the values of the stock market indices are known as volatility. Volatility is measured by the standard deviation of the prices of the market on a day to day basis. Sustained shifts in volatility can be utilized to forecast upcoming economic variables; stock market instability serves to envisage growth in GDP. The performance of the SEM is determined by the volatility (i.e. standard deviation) in the return of the SEMDEX and by stock market growth. Given that the official market and the Development and Enterprise market are not interconnected the SEM is not exposed to volatility spillover. Securities markets add to economic growth by making capital investments more liquid. Many lucrative investments necessitate a long-standing commitment of capital, but investors might not want to keep their savings for such lengthy time. A liquid stock market enables investors to convert their investments into cash whenever required, in so doing making stocks rather more attractive investments. While investors happen to be relaxed with investing for the long term equities, they are likely to restructure their portfolios, by including more equities and less shorter-term financial instruments. For companies, this rebalancing reduces the expenditure of moving to more profitable-that is, more productive-longer-term projects. Capital with higher productivity, in turn, enhances economic development. It also boosts proceeds on investments in shares which may encourage people to save more, contributing further to investment in physical capital and thus stimulating growth of the economy. Nonetheless, a few economists argue that markets which are very liquid hinder economic progress. By letting investors to dispose of their investments swiftly, liquid markets may diminish investor commitment and decrease incentives of equity owners to exercise corporate management by supervising the performance of managers and firms. In other words, displeased holders sell their stocks instead of working to improve the firm’s operations. According to this analysis, high liquidity in the stock market may hold back economic growth by hindering corporate governance.
Expected asset price variations are used to assess market risk and unforeseeable price swings are supposed to be a sign of uncertainty. Volatility of returns is the most widely used concept for representing risk. Historical volatility is used to study past or present prices and projected volatility (or the implied volatility obtained from option prices) is used to forecast future price changes. Under this approach, the only real problem for the various agents in the financial economy stems from unpredicted volatility.
