Volatility is rough
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Publication:4554473
DOI10.1080/14697688.2017.1393551zbMATH Open1400.91590arXiv1410.3394OpenAlexW3124875579MaRDI QIDQ4554473FDOQ4554473
Authors: Jim Gatheral, Thibault Jaisson, Mathieu Rosenbaum 
Publication date: 14 November 2018
Published in: Quantitative Finance (Search for Journal in Brave)
Abstract: Estimating volatility from recent high frequency data, we revisit the question of the smoothness of the volatility process. Our main result is that log-volatility behaves essentially as a fractional Brownian motion with Hurst exponent H of order 0.1, at any reasonable time scale. This leads us to adopt the fractional stochastic volatility (FSV) model of Comte and Renault. We call our model Rough FSV (RFSV) to underline that, in contrast to FSV, H<1/2. We demonstrate that our RFSV model is remarkably consistent with financial time series data; one application is that it enables us to obtain improved forecasts of realized volatility. Furthermore, we find that although volatility is not long memory in the RFSV model, classical statistical procedures aiming at detecting volatility persistence tend to conclude the presence of long memory in data generated from it. This sheds light on why long memory of volatility has been widely accepted as a stylized fact. Finally, we provide a quantitative market microstructure-based foundation for our findings, relating the roughness of volatility to high frequency trading and order splitting.
Full work available at URL: https://arxiv.org/abs/1410.3394
Recommendations
option pricingfractional Brownian motionlong memoryvolatility persistencehigh frequency datavolatility forecastingvolatility surfacefractional Ornstein-Uhlenbeckvolatility smoothness
Derivative securities (option pricing, hedging, etc.) (91G20) Fractional processes, including fractional Brownian motion (60G22) Diffusion processes (60J60)
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