The small-maturity Heston forward smile

DOI10.1137/13091703XzbMATH Open1283.91177arXiv1303.4268OpenAlexW3121632361MaRDI QIDQ2873151FDOQ2873151

Patrick Roome, Antoine Jacquier

Publication date: 23 January 2014

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

Abstract: In this paper we investigate the asymptotics of forward-start options and the forward implied volatility smile in the Heston model as the maturity approaches zero. We prove that the forward smile for out-of-the-money options explodes and compute a closed-form high-order expansion detailing the rate of the explosion. Furthermore the result shows that the square-root behaviour of the variance process induces a singularity such that for certain parameter configurations one cannot obtain high-order out-of-the-money forward smile asymptotics. In the at-the-money case a separate model-independent analysis shows that the small-maturity limit is well defined for any Ito diffusion. The proofs rely on the theory of sharp large deviations (and refinements) and incidentally we provide an example of degenerate large deviations behaviour.

Full work available at URL: https://arxiv.org/abs/1303.4268

zbMATH Keywords

asymptotic expansionstochastic volatilityHeston modelforward implied volatility

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Large deviations (60F10) Numerical methods (including Monte Carlo methods) (91G60) Stochastic models in economics (91B70)

Cited In (14)

• The implied volatility of Forward-Start options: ATM short-time level, skew and curvature
• Asymptotic Behavior of the Fractional Heston Model
• The characteristic function of rough Heston models
• Black-Scholes in a CEV random environment
• Short Maturity Forward Start Asian Options in Local Volatility Models
• Large-maturity regimes of the Heston forward smile
• Stationary covariance regime for affine stochastic covariance models in Hilbert spaces
• Asymptotics of Forward Implied Volatility
• Weighted average price in the Heston stochastic volatility model
• General smile asymptotics with bounded maturity
• Distance to the line in the Heston model
• Small‐time, large‐time, and asymptotics for the Rough Heston model
• The Randomized Heston Model
• Forward starting options pricing under a regime-switching jump-diffusion model with Wishart stochastic volatility and stochastic interest rate

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