Volatility is a Reliable and Convenient Proxy for Downside Risk

Javier Estrada, author of the June 2025 study “Volatility: A Dead Ringer for Downside Risk” tackled a longstanding debate in finance: Is volatility (the standard deviation of returns) a good measure of the risk that investors actually care about? While volatility is the most widely used risk metric in investing, it is also heavily criticized, especially by those who argue that investors are primarily concerned with downside risk—the risk of losses—rather than the mere variability of returns.

Estrada investigated whether volatility, despite its limitations, serves as an effective stand-in for downside risk by comparing how assets were ranked using volatility versus alternative downside risk metrics: semi-deviation (SSD), probability of loss (PL), average loss (AL), expected loss (EL), worst loss (WL), maximum drawdown (MD), and Value at Risk (VaR). His data sample consisted of the MSCI database of 47 countries (23 developed and 24 emerging) each considered from its inception in the database through December 2024.

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