Understanding Interest Rate Volatility: Definition & Significance

A woman touching a bar graph on a tablet computer.

In finance, the volatility of key indicators, such as stock prices, the unemployment rate and, especially, interest rates is critically important. Volatility is a measure of variability over a specific time period. While there are various ways of measuring this metric, a simple measure of interest rate volatility is how much interest rates move up or down, on average, per day, week or month. Other measures such as standard deviation and variance are more complex, but in essence, they measure the same thing: how wildly interest rates tend to increase or decrease, on average, over a specified time period.

Significance

Wild swings in interest rates make financial planning difficult for all players in the economy. Home buyers tend to wait for a downswing in general interest rates, because mortgage rates usually decline in lockstep with general rates in the economy. This slows down home sales when rates are high. Large companies similarly tend to hold off on borrowing and postpone key investments while they assess the financial landscape. Banks find it very hard to plan and forecast profits if the rates at which they can borrow and lend are highly variable. Policymakers therefore watch interest rate volatility closely and take measures to curb excess volatility.