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R-2GAM stochastic volatility model: flexibility and calibration

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  • Cheng-Few Lee
  • Oleg Sokolinskiy

Abstract

This paper investigates the potential of the 2GAM stochastic volatility model for capturing varying properties of option prices represented by the implied volatility surface. The 2GAM model is shown to be a generalization of the Heston model. Then, taking the original Heston model as the benchmark, the paper explores the flexibility allowed by the 2GAM model. More precisely, the focus is on the restricted 2GAM (R-2GAM) model which builds upon the Heston model reproducing a given short-term implied volatility skew. Going from theory to practice, the paper suggests a numerically-feasible calibration procedure for the R-2GAM model. In an application to the valuation of the S&P 500 option contracts this paper addresses the challenges of calibrating the R-2GAM model to market prices and raises concerns of possible over-parameterization. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • Cheng-Few Lee & Oleg Sokolinskiy, 2015. "R-2GAM stochastic volatility model: flexibility and calibration," Review of Quantitative Finance and Accounting, Springer, vol. 45(3), pages 463-483, October.
    • Handle: RePEc:kap:rqfnac:v:45:y:2015:i:3:p:463-483
    DOI: 10.1007/s11156-014-0443-7
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    Cited by:

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    2. Fathi Abid & Bilel Kaffel, 2018. "The extent of virgin olive-oil prices’ distribution revealing the behavior of market speculators," Review of Quantitative Finance and Accounting, Springer, vol. 50(2), pages 561-590, February.
    3. Gurdip Bakshi & Charles Cao & Zhaodong (Ken) Zhong, 2021. "Assessing models of individual equity option prices," Review of Quantitative Finance and Accounting, Springer, vol. 57(1), pages 1-28, July.

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    More about this item

    Keywords

    Stochastic volatility; Implied volatility smile; Calibration; G13;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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