Asymptotics for volatility derivatives in multi-factor rough volatility models (Q2037765)

For a log stock price process \(X\) defined as \(X_t=-\frac{1}{2} \int_{0}^{t} v_s\,\mathrm{d}s+ \int_{0}^{t} \sqrt{v_s}\, \mathrm{d}B_s\), \(X_0 =0\), where \(B\) is standard Brownian motion, and the quadratic variation of \(X\) at time \(t\) is denoted by \(\langle X \rangle_t\), this paper analyzes the short time behaviour of the realised variance option with payoff given by \[ \left( \frac{1}{T} \int_{0}^{T} \, {\textup{d}}\langle X \rangle_s -K \right)^+ \, . \] This is done for a number of stochastic volatility models by means of large deviation techniques. The paper focuses on the construction of correlated factors and their effect on the distribution of the realised variance. So, it deals with the small-time behaviour of the realised variance process of the rough Bergomi model, as well as related but more complicated multi-factor rough volatility models, together with the small-time behaviour of options on realised variance. The results obtained are interesting from a theoretical perspective, and also have practical applicability to the quantitative finance industry. This applicability of the results allows practitioners to better understand the realised variance smile, as well as the effect of correlation on the smile's linearity (or possibly convexity). Another major contribution of the paper is the numerical scheme used to compute the implied volatility smiles, using an accurate approximation of the rate function from a large deviations principle. In general rate functions are highly non-trivial to compute. However, the method presented in this paper is easy to understand, and precise.