A Stylized History of Volatility

Abstract

The evolution of a quantitative approach to finance has proceeded through many small but significant steps and occasional large epiphanies concerning the management of volatility.

This article outlines how philosophers, physicists, and financial modelers have quantified the notion of derivatives, diffusion, risk, volatility, the riskless rate, diversification, hedging, replication, and the principle of no riskless arbitrage. Volatility, once a qualitative term, has become an asset that can be traded via models. But the models are always necessarily inadequate, and it is their very failure that opens up the possibility of trading the parameters they introduce.

Keywords: Volatility, Options, Finance, Philosophy

JEL Classification: G10, G12, G13