What Is the Relationship between the Discount Rate and the Volatility of the Underlying Asset?

There is a direct relationship: the higher the volatility of the underlying asset, the higher the discount rate should be. Volatility is a measure of risk; a highly volatile asset has a wider range of potential future cash flows, increasing the uncertainty of the investment.

To compensate investors for taking on this higher level of risk, a higher discount rate is required to reduce the present value of those uncertain future cash flows.