Fintech Reach

Module 8:
Volatilities, Correlations, and Dependence

1. Module Overview

This module explains three key concepts in risk management: volatility, correlation, and dependence. These concepts help measure how assets behave individually and in relation to each other, which is essential for portfolio construction and risk control.

2. Learning Objectives

By the end of this module, you will be able to:

Understand volatility as a measure of risk
Explain correlation between assets
Distinguish between correlation and dependence
Apply these concepts to portfolio diversification

3. Volatility

3.1 What Is Volatility

Volatility measures how much an asset’s price moves over time.

Key idea:

Higher volatility = higher uncertainty and risk

3.2 Simple Illustration

Low Volatility        High Volatility  

Price                 Price
   |                     |
   |  ---                |  /\  /\
   | /   \               | /  \/  \
   |/     \              |/        \
   ----------------     ----------------> Time

Meaning:

Low volatility → stable prices
High volatility → large fluctuations

3.3 Why Volatility Matters

Determines option pricing (higher volatility → higher option value)
Indicates market uncertainty
Used in risk models such as VaR

4. Correlation

4.1 What Is Correlation

Correlation measures how two assets move relative to each other.

Correlation	Meaning
+1	Move together perfectly
0	No relationship
-1	Move in opposite directions

4.2 Simple Diagram

Positive Correlation     Negative Correlation   
   /\        /\             /\      \/
  /  \      /  \           /  \    /  \
 /    \    /    \         /    \  /    \
-------------------     -------------------

4.3 Why Correlation Matters

Helps reduce risk through diversification
Key input in portfolio management
Used in risk calculations and asset allocation

5. Dependence

5.1 What Is Dependence

Dependence describes a broader relationship between assets, beyond simple correlation.