The characteristic function of rough Heston models

DOI10.1111/MAFI.12173MaRDI QIDQ5743116zbMATH OpenOpenAlexFDO

Authors Omar El Euch, Mathieu Rosenbaum

Publication date 8 May 2019

Published in Mathematical Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1609.02108

zbMATH Keywords

fractional Brownian motionfractional Riccati equationHawkes processeslimit theoremsrough Heston modelsrough volatility models

Mathematics Subject Classification ID

Fractional processes, including fractional Brownian motion (60G22) Point processes (e.g., Poisson, Cox, Hawkes processes) (60G55) Stochastic models in economics (91B70) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: It has been recently shown that rough volatility models, where the volatility is driven by a fractional Brownian motion with small Hurst parameter, provide very relevant dynamics in order to reproduce the behavior of both historical and implied volatilities. However, due to the non-Markovian nature of the fractional Brownian motion, they raise new issues when it comes to derivatives pricing. Using an original link between nearly unstable Hawkes processes and fractional volatility models, we compute the characteristic function of the log-price in rough Heston models. In the classical Heston model, the characteristic function is expressed in terms of the solution of a Riccati equation. Here we show that rough Heston models exhibit quite a similar structure, the Riccati equation being replaced by a fractional Riccati equation.

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• FracPECE

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