Multi-factor approximation of rough volatility models
Probability
2018-04-12 v3 Computational Finance
Pricing of Securities
Abstract
Rough volatility models are very appealing because of their remarkable fit of both historical and implied volatilities. However, due to the non-Markovian and non-semimartingale nature of the volatility process, there is no simple way to simulate efficiently such models, which makes risk management of derivatives an intricate task. In this paper, we design tractable multi-factor stochastic volatility models approximating rough volatility models and enjoying a Markovian structure. Furthermore, we apply our procedure to the specific case of the rough Heston model. This in turn enables us to derive a numerical method for solving fractional Riccati equations appearing in the characteristic function of the log-price in this setting.
Keywords
Cite
@article{arxiv.1801.10359,
title = {Multi-factor approximation of rough volatility models},
author = {Eduardo Abi Jaber and Omar El Euch},
journal= {arXiv preprint arXiv:1801.10359},
year = {2018}
}