Introduction

In recent years a great deal of theoretical and empirical work has been published on the movements of equity share prices. This reflects the considerable interest currently being shown in the formation and performance of investment portfolios, particularly with regard to their equity (share) content. Controlling a portfolio is essentially a matter of making buy-and-sell decisions and, since portfolio managers must be interested in future performance, information about future prospects is needed. Newspapers and stockbrokers commonly give only limited help with enigmatic statements such as ‘… the market for electrical shares could be up 25% within the year, or even more if inflation moderates. On the other hand it could…’

An analyst faced with this portfolio management problem would doubtless start by analysing the past variability of shares. Of course, there is no guarantee that the future mirrors the past, but it is reasonable to assume that a portfolio composed of shares with histories of high variability will also have a less predictable future performance than a portfolio of shares whose past performance has been more stable. The basic concept in portfolio management theory is that some shares are consistently more volatile or variable than other shares. The more variable the company's shares, the riskier is that share.

Share variability

The monthly fluctuations in price over four years for a share that is generally regarded by analysts as having high risk (Paterson Zochonis) and one that is similarly regarded as having low risk (British American Tobacco) are shown in Figure 8.1. The values have been adjusted to a common starting price of 100, with all dividends re-invested.