English

Exponential L\'evy-type models with stochastic volatility and stochastic jump-intensity

Pricing of Securities 2013-07-12 v5 Computational Finance General Finance

Abstract

We consider the problem of valuing a European option written on an asset whose dynamics are described by an exponential L\'evy-type model. In our framework, both the volatility and jump-intensity are allowed to vary stochastically in time through common driving factors -- one fast-varying and one slow-varying. Using Fourier analysis we derive an explicit formula for the approximate price of any European-style derivative whose payoff has a generalized Fourier transform; in particular, this includes European calls and puts. From a theoretical perspective, our results extend the class of multiscale stochastic volatility models of \citet*{fpss} to models of the exponential L\'evy type. From a financial perspective, the inclusion of jumps and stochastic volatility allow us to capture the term-structure of implied volatility. To illustrate the flexibility of our modeling framework we extend five exponential L\'evy processes to include stochastic volatility and jump-intensity. For each of the extended models, using a single fast-varying factor of volatility and jump-intensity, we perform a calibration to the S&P500 implied volatility surface. Our results show decisively that the extended framework provides a significantly better fit to implied volatility than both the traditional exponential L\'evy models and the fast mean-reverting stochastic volatility models of \citet{fpss}.

Keywords

Cite

@article{arxiv.1205.2398,
  title  = {Exponential L\'evy-type models with stochastic volatility and stochastic jump-intensity},
  author = {Matthew Lorig and Oriol Lozano-Carbassé},
  journal= {arXiv preprint arXiv:1205.2398},
  year   = {2013}
}

Comments

24 pages, 4 figures, 2 tables

R2 v1 2026-06-21T21:01:58.296Z