The randomized Heston model

DOI10.1137/18M1166420MaRDI QIDQ5742496zbMATH OpenOpenAlexFDO

Authors Antoine Jacquier, Fangwei Shi

Publication date 14 May 2019

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

Full work available at URL https://arxiv.org/abs/1608.07158

zbMATH Keywords

asymptotic expansionHestonimplied volatilitylarge deviationsstochastic volatility

Mathematics Subject Classification ID

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

Abstract: We propose a randomised version of the Heston model-a widely used stochastic volatility model in mathematical finance-assuming that the starting point of the variance process is a random variable. In such a system, we study the small-and large-time behaviours of the implied volatility, and show that the proposed randomisation generates a short-maturity smile much steeper (`with explosion') than in the standard Heston model, thereby palliating the deficiency of classical stochastic volatility models in short time. We precisely quantify the speed of explosion of the smile for short maturities in terms of the right tail of the initial distribution, and in particular show that an explosion rate of~$t^{g}amma$ ($gammain[0,1/2]$) for the squared implied volatility--as observed on market data--can be obtained by a suitable choice of randomisation. The proofs are based on large deviations techniques and the theory of regular variations.

Recommendations

• SMALL-TIME ASYMPTOTICS FOR IMPLIED VOLATILITY UNDER THE HESTON MODEL
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• Black-Scholes in a CEV random environment

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• Black-Scholes in a CEV random environment
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