Variance - Financial definition
Concise definition of the term variance
Variance measures the extent to which a set of data points deviate from the mean, providing insight into the data's dispersion and variability.
Comprehensive definition of the term variance
Variance, a fundamental concept in statistics and probability theory, quantifies the spread of data points around their mean value. It is calculated by averaging the squared differences between each data point and the mean, offering a numerical measure of dispersion within the dataset.
In finance, variance quantifies the extent to which individual returns of a financial asset or portfolio deviate from their mean value over a specific period. This measure is crucial for assessing the level of risk inherent in an investment, as assets with higher variance typically exhibit greater price fluctuations and are considered riskier.
Investors often use variance alongside other risk metrics like standard deviation and covariance to construct diversified portfolios that balance risk and return. For instance, in portfolio management, understanding variance helps investors optimize asset allocation strategies by minimizing overall portfolio risk while maximizing potential returns.