The Measurement of the Volatility of Common Stock Prices

Author(s): George E. Pinches and William R. Kinney, Jr.

Source: The Journal of Finance , Mar., 1971, Vol. 26, No. 1 (Mar., 1971), pp. 119-125
Published by: Wiley for the American Finance Association

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 THE MEASUREMENT OF THE VOLATILITY OF
COMMON STOCK PRICES

GEORGE E. PINCHES AND WILLIAM R. KINNEY, JR.*

INVESTMENT in common stock is, in essence, a present sacrifice in exchange

for expected future benefits. Since the present is known, this investment be-
comes a certain sacrifice for an uncertain or risky benefit. This paper concerns
the measurement of common stock price volatility as a risk surrogate.
Attempts to measure volatility have primarily been directed toward de-
veloping performance measures for mutual funds or other security portfolios.'
Few attempts have been made to measure price volatility of individual stocks,
and these have been primarily concerned with separating the volatility into
market-related and residual (or firm) volatility.2
The purpose of this study is to test whether there are significant differences
in volatility rankings of individual common stocks depending on the measure-
ment technique employed.3 If there are few differences in relative rankings, it
could be argued that one of the simpler measurement techniques should be
employed. However, if relative rankings differ significantly, the specific
characteristics of the measures become an important matter for consideration.
An analysis based on historical volatility may be questioned since historical
volatility bears no necessary relationship to future volatility. However, histor-
ical volatility may be useful as a predictor of future volatility if a volatility
measure has yielded fairly stable ranking results over past periods.4 The
stability of the rankings over time will also be tested.

I. PRICE VOLATILITY MEASURES

Many different measures of volatility have been suggested in the literature.

Three basic types of measures will be considered here: high-low measures;
measures of dispersion around an arithmetic mean; and measures of dispersion
around a quadratic mean.
Specifically, the following measures of individual common stock price
volatility were considered.

A. Range Divided by Mid-Range

Ph - PL

(Ph + PL)/2

* Associate Professor of Finance, Oklahoma State University, and Associate Professor of Account-
ing, The University of Iowa, respectively.
1. Sharpe (13), Treynor (15) and Jensen (8).
2. Treynor et al. (16), and Altman and Schwartz (2).
3. All of the measures have been, or could be, employed to measure total common stock price
volatility. Traditional utility theory does not support usage of certain of the measures tested;
therefore, the association between volatility rankings needs further examination. See Markowitz
(11) for a discussion of the relationship of utility maximization to some of the measures tested.
4. See Pratt (12) for an examination of volatility over time.

119

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120 The Journal of Finance

where Ph is the high stock price for the period and PL is the low price for the
same period.'

B. Variance
n

Z p ( p)2 /n

where P1 is the price for a sub-period of time, P is the arithmetic mean of

prices over the period, and n is the number of sub-periods.

C. Mean Absolute Deviation

n

Z - Pi-P I /n

where Pi, P and n are defined as in B above.6

D. Coefficient of Variation of Prices

(IE( Pi- _) 2/11n /PF

where Pi, P and n are as defined in B above.7

E. Coefficient of Variation of Price Changes

(|E(di-d)2/n/d-
where di - Pi - Pi-1 for sub-periods i from 1 to n, d is the arithmetic mean
of the di's and n is the number of sub-periods.8

F. Semi-Variance
n

(p p)2/n

where Pi - Pi for Pi < P, Pi = O for Pi > P; P and n are as defined in B

above.9

5. This measure has been employed by Clendenin (3) and Heins and Allison (7). Various modifi-
cations of this measure have been employed by Fisher (5), Eisenstadt (4), Alexander (1), and
Gould (6).
6. This measure has been recommended by a Bank Administration Institute study on meas
pension fund investment performance and was employed by Jensen (8, p. 400).
7. This measure has been employed by Levy (10, p. 599).
8. Levy (10, p. 610).
9. Markowitz (11, pp. 188-201).

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 Volatility of Stock Prices 121

G. Modified Quadratic Mean Considering Only Adverse Returns

I n

\|E(R;)2/n

where RI = (Pt - Pi_1)/P_1,, for Pi - Pi-1 < 0; Ri = 0, for Pi - Pi-, > 0;

Pi and n are as defined above.10

H. Modified Quadratic Mean of the Logarithms of Sub-Period "Value Rela-

tives"

Z (Ln(l'+ Ri))2/n

where RI and n are as defined in G above."

To test the degree of association in volatility rankings of stocks among
different measures, fifty companies were selected at random from Standard
and Poor's list of 425 industrial stocks. Weekly price data (high, low, and
closing) were obtained for 260 consecutive weeks from January, 1963,
through December, 1967.12 Prices were adjusted for all stock dividends and
stock splits.
The data were divided into 26-week periods. The 26-week period was
chosen because it provided an adequate number of observations and the prob-
lem of accounting for trend in price over a relatively long period of time was
avoided. Also, federal income tax considerations make the six-month period a
relevant one for many investment decisions.
The results of employing the eight suggested measures of common stock
price volatility are presented in the following section.

II. DIFFERENCES IN RANKINGS AMONG MEASURES

Each volatility measure was applied to each firm's set of prices for every
time period. To test the degree of association of rankings among measures, the
Kendall coefficient of concordance'3 was computed for each period. The null
hypothesis of no community of order among the measures was rejected at
the .05 significance level for each time period (Table 1). This result could
have arisen because some individual measures have characteristics which are
quite similar to some of the other measures, and thus a high rank correlation
exists between these pairs.

10. Levy (9, p. 43).

11. Levy (9, pp. 43-44).
12. Two limitations of the data need specific comment. First, the results obtained are from large
firms and therefore do not necessarily apply to small firms. Second, since weekly data were em-
ployed, any generalizations made about measures of price volatility when daily data are employed
may be hazardous.
13. Siegel (14, pp. 229-238).

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 122 The Journal of Finance

TABLE 1
COEFFICIENT OF CONCORDANCE AMONG ALL EIGHT MEASURES FOR EACH TWENTY-SIX
WEEK PERIOD

Coefficient
of concordance Test statistic

Period number 1 .618 242.4

Period number 2 .601 235.9
Period number 3 .612 240.0
Period number 4 .626 245.6
Period number 5 .632 248.0
Period number 6 .622 244.1
Period number 7 .633 248.3
Period number 8 .640 251.0
Period number 9 .613 240.3
Period number 10 .628 246.3

2
X95 (49) = 66.3.

To test the degree of association between individual measures the Spearman

rank correlation coefficient'4 (which is the same as the coefficient of con-
cordance when only two treatments are being compared) was computed for
all pairs of measures for all time periods (Table 2). The number of periods in
which the rank correlation coefficient was positive and significant at the .05
level is tabulated for all pairs of measures.

TABLE 2
NUMBER OF PERIODS IN WHICH SPEARMAN RANK CORRELATION COEFFICIENT WAS
POSITIVE AND SIGNIFICANT AT THE .05 LEVEL

B. C. D. E. F. G. H.
Modified
Quadratic
CofV Mean
Var MAD CofV Pr C S-v MQM (logarithms)

A. Range+. midrange 9 9 10 7 9 9 9
B. Variance 10 9 5 1 9 9
C. Mean absolute 9 4 1 9 9
deviation

D. Coefficient of 6 9 9 9
variation

E. Coefficient of 1 9 9
variation of
price changes

F. Semi-variance 10 9
G. Modified quadratic 10
mean

Note that the simplest measure, the range divided by the mid-range, has
correlation with other measures which is positive and significant for 62 com-

14. Siegel (14, pp. 202-213).

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 Volatility of Stock Prices 123

parisons of a possible 70 over the five-year period. It also has positive and
significant correlation with the two somewhat erratic measures, the semi-
variance and the coefficient of variation of price changes.15
Substantial agreement in every time period exists between four sets of
measures. These are: the range divided by the mid-range and the coefficient
of variation (each measuring relative dispersion); the variance and the mean
absolute deviation (each measuring absolute dispersion); the semi-variance
and the modified quadratic mean (each giving weight to downward dispersion
only); and the two modified quadratic mean measures suggested by Levy
(each measuring downward changes in sub-period rates of return).
If only the range divided by the mid-range, the variance, the coefficient
of variation of price changes, and the semi-variance are included, the coeffi-
cient of concordance is significant (that is, the hypothesis of no community of
order is rejected) for only six of the ten periods (Table 3). Thus, there is a

TABLE 3
COEFFICIENT OF CONCORDANCE AMONG THE RANGE DIVED BY THE MID-RANGE, THE
VARIANCE, THE COEFFICIENT OF VARIATION OF PRICE CHANGES AND THE
SEMI-VARIANCE FOR EACH TWENTY-SIX WEEK PERIOD

Coefficient
of concordance Test statistic

Period number 1 .373 73.2

Period number 2 .307 60.3
Period number 3 .319 62.6
Period number 4 .336 65.9
Period number 5 .377 74.0
Period number 6 .358 70.3
Period number 7 .335 65.7
Period number 8 .397 77.8
Period number 9 .402 78.9
Period number 10 .396 77.6

.95(49)= 66.3

lower degree of association among these four conceptually dissimilar measures

of volatility. This implies that an investor should give some consideration to
defining the type of risk he is trying to minimize and choose a measure that
will reflect differences in volatility according to his own risk preference.
Worthy of particular consideration are the two measures which exhibit the
lowest relative frequency of significant positive correlation10 with the other
measures-the semi-variance and the coefficient of variation of price changes.
The semi-variance yields rankings which are substantially in agreement with

15. When compared with some measures for some time periods, these two measures had significant
negative correlations. There were five such cases involving the semi-variance (three with the co-
efficient of variation of price changes, and one each with the variance and mean absolute deviation).
There were seven cases for the coefficient of variation of price changes (three with the semi-
variance, and one each with the range divided by the mid-range, the coefficient of variation and each
of the measures using a modified quadratic mean). All significant negative correlations involved one
or both of these two measures.
16. See Footnote 15.

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 124 The Journal of Finance

the variance and the mean absolute deviation in only one period each. This
suggests that the distributions of stock prices are not symmetric. The coeffi-
cient of variation of price changes has relatively high correlation with only the
measures suggested by Levy (which also depend upon price changes over sub-
periods). This measure should be considered for short-term investments since
it does reflect changes in price from sub-period to sub-period.

III. DIFFERENCES iN RANKING OVER TIME

To test stability over time, the volatility rankings computed above were
used to compute the coefficient of concordance for each measure among time
periods. The null hypothesis of no community of order of rankings among
periods was rejected for seven of the eight measures (Table 4). Only for the

TABLE 4
COEFFICIENT OF CONCORDANCE AMONG TIME PERIODS FOR EACH MEASURE

Coefficient
Measure of concordance Test statistic

A. Range . midrange .130 64.1

B. Variance .227 111.2

C. Mean absolute deviation .265 130.2

D. Coefficient of variation .228 112.2

E. Coefficient of variation .338 165.6
of price changes

F. Semi-variance .282 138.5

G. Modified quadratic mean .220 107.6

H. Modified quadratic mean .219 107.5
(logarithms)

X.95(49)- 66.3

range divided by the mid-range could the hypothesis not be rejected. The lack
of stability of the range divided by the mid-range was to be expected since
it depends on extreme values. Extreme values may vary considerably among
periods even though week-to-week fluctuations in price for a particular stock
remain relatively constant over time.

IV. CONCLIUSIONS

In this study we have tried to determine whether the measures of stock

price volatility suggested in the literature yield substantially the same ranking
results through an application of the measures to a sample of fifty companies.
The results of the empirical study indicate that there is significant agreement
among the eight volatility measures over the twenty-six-week time periods.
However, when four of the measures which reflect similar types of events are
excluded, there is significant agreement in only six of the ten periods. Thus for
some types of decisions, the differences among rankings may be important and
a measure of volatility should be chosen to reflect the individual decision
maker's definition of risk.
With respect to future volatility, test results indicate that for each of the

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 Volatility of Stock Prices 125

measures (except the range divided by the mid-range) past volatility is, over
time, a relatively good predictor of future volatility.
Since volatility has been used as a risk surrogate, this study could be
profitably extended by an experiment to determine whether any of the sug-
gested volatility measures approximate investment decision makers' subjective
rankings of stocks as to risk. A sample of investors or financial analysts could
be asked to rank a relatively small number of stocks as to risk and compare
these rankings with the objective volatility rankings as computed above. If
substantial agreement among investors seems to exist, the reporting of vola-
tility measures by investment services may be justified.
Three other extensions may also be of value. First, the separation of market
volatility from the total volatility may yield ranking results (based on residual
or firm volatility) which are significantly different from those based on total
volatility. Second, the effect of the length of the time period over which the
measures are computed may be important. The range divided by the mid-
range particularly is likely to be quite satisfactory for short periods and un-
satisfactory for longer periods. Finally, the changes in measures when daily
rather than weekly prices are used should be explored.

REFERENCES

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