Short-time expansions for close-to-the-money options under a Lévy jump model with stochastic volatility (Q261928)

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Short-time expansions for close-to-the-money options under a Lévy jump model with stochastic volatility
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    Short-time expansions for close-to-the-money options under a Lévy jump model with stochastic volatility (English)
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    29 March 2016
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    Exponential asset price models of the form \(S_t=S_0e^{X_t+V_t}\), \(t\geq0\), where \(X_t\) is a pure-jump tempered-stable type Lévy process and \(V_t\) is either the zero process, the Brownian motion process, or a stochastic volatility process independent of \(X_t\) (e.g. mean reverting Heston or Ornstein-Uhlenbeck), are considered in this paper. The authors first look at the case \(V_t\equiv0\), revisit the second-order approximation for the at-the-money (ATM) option prices, i.e. \(\mathbb{E}(S_t-S_0e^{\kappa})^+\) with \(\kappa=0\), presented in [the first author et al., Math. Finance 26, No. 3, 516--557 (2016; Zbl 1348.91268)], relax the conditions on the Lévy density of \(X_t\) to the minimum for the expansion to be well-defined, and show how this expansion extends to the close-to-the-money strikes, i.e. when the deterministic log-strike \(\kappa=\kappa_t\downarrow 0\) as \(t \downarrow 0\). Then a similar close-to-the-money expansion is shown to hold when \(V_t\) is an independent stochastic volatility process. Numerical simulations with a CGMY process as \(X_t\) and various choices for \(V_t\) illustrate the obtained approximations.
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    exponential Lévy models
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    stochastic volatility models
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    short-time asymptotics
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    ATM option pricing
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    implied volatility
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