How does volatility relate to risk management?

Volatility is a key concept in risk management as it quantitatively measures the degree of variation of a trading price series over time. In financial markets, volatility indicates how much and how quickly the price of an asset fluctuates, which directly relates to the risk associated with that asset. Higher volatility suggests greater uncertainty and potential for significant price swings, which can lead to higher risk for investors and traders.

Understanding volatility is crucial for risk management because it helps practitioners assess potential losses and gains, make informed decisions about asset allocation, and develop strategies such as hedging to mitigate potential adverse effects caused by price fluctuations.

While other options touch on aspects of finance, they do not capture the essence of how volatility functions as a measure of risk. For instance, indicating fixed returns pertains specifically to bonds, average return pertains more to expected performance rather than variability, and correlation deals with relationships between asset classes, none of which directly address the concept of volatility.