Many reluctantly recall their statistics lectures: formulas, variance, standard deviation – and the question: What’s the point of it all? However, standard deviation holds a real treasure: it is a central tool in modern risk management.
In this edition of “Insights and Strategies from EIQF,” we show why standard deviation is more than just an abstract calculation – it is the mathematical expression of risk.
In everyday life, we usually understand risk as a threat. In financial science, however, the definition is more neutral – and more precise:
Risk is the deviation from the expected value.
This means: Risk can swing both upwards (opportunity) and downwards (danger). This perspective is central to professional risk management.
And this is precisely where standard deviation comes into play: it measures how much individual values deviate from the expected value on average – which is exactly what risk means.
This makes it clear: Standard deviation is the scientific definition of risk – expressed in numbers.
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Especially in finance, it is crucial not only to identify risks but also to measure them quantitatively. Standard deviation allows precisely that:
Anyone who understands this metric masters one of the most important foundations of quantitative risk management.
To illustrate, a simple example helps: If a payment of 10 euros occurs for the first time in year t = 1 and then annually towards infinity, the present value is 10/0.1=100 and refers to the year at t = 0. From this, we can draw the following conclusion. When we discount cash flows, the present value of these payments always refers to the point in time one period before the first cash flow occurs.
The same applies to the calculation of the Terminal Value: The TV is the present value of payments in the continuation period, which arise in years t = 6, …, ∞. The Terminal Value summarizes all future payments from year t = 6 onwards – however, its calculation refers to the valuation date t = 5, i.e., one period before the first cash flow of the continuation period.
Youtube Linkedin Envelope Table of Contents Have you ever wondered why, when calculating the standard deviation, we sometimes divide by 𝓷 and sometimes by 𝒏-1?
Youtube Linkedin Envelope Table of Contents In corporate planning practice, the cash flow statement has often been neglected to date, even though it represents a
Youtube Linkedin Envelope Table of Contents In an increasingly volatile and crisis-prone world, traditional deterministic management planning is reaching its limits. Target-value-oriented planning systematically ignores
Youtube Linkedin Envelope Table of Contents Exactly 100 years ago, in 1925, Werner Heisenberg published his groundbreaking article: 👉 “On the Quantum-Theoretical Reinterpretation of Kinematic
The semi-standard deviation (also downside deviation) measures the dispersion below a reference value (usually the mean or a target return such as 0%).
Many reluctantly recall their statistics lectures: formulas, variance, standard deviation – and the question: What’s the point of it all? However, standard deviation holds a real treasure: it is a central tool in modern risk management.
