Asymptotics for Rough Stochastic Volatility Models

DOI10.1137/15M1009330MaRDI QIDQ2962133zbMATH OpenOpenAlexFDO

Authors Martin Forde, Hongzhong Zhang

Publication date 16 February 2017

Published in SIAM Journal on Financial Mathematics (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1610.08878

zbMATH Keywords

fractional Brownian motionfractional stochastic volatilityimplied volatility asymptoticslarge deviationsrough paths

Mathematics Subject Classification ID

Large deviations (60F10) Fractional processes, including fractional Brownian motion (60G22) Stochastic analysis (60H99) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: Using the large deviation principle (LDP) for a re-scaled fractional Brownian motion $B_t^H$ where the rate function is defined via the reproducing kernel Hilbert space, we compute small-time asymptotics for a correlated fractional stochastic volatility model of the form $$ where $sigma$ is $alpha$-H"{o}lder continuous for some $alphain(0,1]$; in particular, we show that $t^{H-frac12}log{S}_t$ satisfies the LDP as $to0$ and the model has a well-defined implied volatility smile as $to0$, when the log-moneyness $k(t)=x{t}^{frac12-H}$. Thus the smile steepens to infinity or flattens to zero depending on whether $Hin(0,frac12)$ or $Hin(frac12,1)$. We also compute large-time asymptotics for a fractional local-stochastic volatility model of the form: $$, and we generalize two identities in Matsumoto&Yor05 to show that $frac1t^{2H}logfrac1tin{t}_0^t{e}^{2B_s^H}ds$ and $frac1t^{2H}(login{t}_0^t{e}^{2(mus+B_s^H)}ds-2mut)$ converge in law to $2mathrm{max}_{0lesle1}{B}_s^H$ and $2B_1$ respectively for $Hin(0,frac12)$ and $mu>0$ as $toinfty$.

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