Local volatility under rough volatility

DOI10.1111/MAFI.12392zbMATH Open1529.91068arXiv2204.02376OpenAlexW4377942496MaRDI QIDQ6187367FDOQ6187367

Paolo Pigato, Florian Bourgey, Stefano De Marco, Peter Friz

Publication date: 31 January 2024

Published in: Mathematical Finance (Search for Journal in Brave)

Abstract: Several asymptotic results for the implied volatility generated by a rough volatility model have been obtained in recent years (notably in the small-maturity regime), providing a better understanding of the shapes of the volatility surface induced by rough volatility models, and supporting their calibration power to S&P500 option data. Rough volatility models also generate a local volatility surface, via the so-called Markovian projection of the stochastic volatility. We complement the existing results on the implied volatility by studying the asymptotic behavior of the local volatility surface generated by a class of rough stochastic volatility models, encompassing the rough Bergomi model. Notably, we observe that the celebrated "1/2 skew rule" linking the short-term at-the-money skew of the implied volatility to the short-term at-the-money skew of the local volatility, a consequence of the celebrated "harmonic mean formula" of [Berestycki, Busca, and Florent, QF 2002], is replaced by a new rule: the ratio of the at-the-money implied and local volatility skews tends to the constant 1/(H + 3/2) (as opposed to the constant 1/2), where H is the regularity index of the underlying instantaneous volatility process.

Full work available at URL: https://arxiv.org/abs/2204.02376

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Applications of rough analysis (60L90)

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Cited In (1)

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