Black-Scholes in a CEV random environment
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Publication:1648901
DOI10.1007/S11579-018-0211-XzbMATH Open1397.91571arXiv1503.08082OpenAlexW2963176811MaRDI QIDQ1648901FDOQ1648901
Authors: Antoine Jacquier, Patrick Roome 
Publication date: 5 July 2018
Published in: Mathematics and Financial Economics (Search for Journal in Brave)
Abstract: Classical (It^o diffusions) stochastic volatility models are not able to capture the steepness of small-maturity implied volatility smiles. Jumps, in particular exponential L'evy and affine models, which exhibit small-maturity exploding smiles, have historically been proposed to remedy this (see cite{Tank} for an overview), and more recently rough volatility models cite{AlosLeon, Fukasawa}. We suggest here a different route, randomising the Black-Scholes variance by a CEV-generated distribution, which allows us to modulate the rate of explosion (through the CEV exponent) of the implied volatility for small maturities. The range of rates includes behaviours similar to exponential L'evy models and fractional stochastic volatility models.
Full work available at URL: https://arxiv.org/abs/1503.08082
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