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Small-time expansions of the distributions, densities, and option prices of stochastic volatility models with Lévy jumps

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  • Figueroa-López, José E.
  • Gong, Ruoting
  • Houdré, Christian

Abstract

We consider a stochastic volatility model with Lévy jumps for a log-return process Z=(Zt)t≥0 of the form Z=U+X, where U=(Ut)t≥0 is a classical stochastic volatility process and X=(Xt)t≥0 is an independent Lévy process with absolutely continuous Lévy measure ν. Small-time expansions, of arbitrary polynomial order, in time-t, are obtained for the tails P(Zt≥z), z>0, and for the call-option prices E(ez+Zt−1)+, z≠0, assuming smoothness conditions on the density of ν away from the origin and a small-time large deviation principle on U. Our approach allows for a unified treatment of general payoff functions of the form φ(x)1x≥z for smooth functions φ and z>0. As a consequence of our tail expansions, the polynomial expansions in t of the transition densities ft are also obtained under mild conditions.

Suggested Citation

  • Figueroa-López, José E. & Gong, Ruoting & Houdré, Christian, 2012. "Small-time expansions of the distributions, densities, and option prices of stochastic volatility models with Lévy jumps," Stochastic Processes and their Applications, Elsevier, vol. 122(4), pages 1808-1839.
    • Handle: RePEc:eee:spapps:v:122:y:2012:i:4:p:1808-1839
    DOI: 10.1016/j.spa.2012.01.013
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    References listed on IDEAS

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    1. Ole E. Barndorff-Nielsen & Neil Shephard, 2006. "Econometrics of Testing for Jumps in Financial Economics Using Bipower Variation," The Journal of Financial Econometrics, Society for Financial Econometrics, vol. 4(1), pages 1-30.
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    Cited by:

    1. Jacquier, Antoine & Roome, Patrick, 2016. "Large-maturity regimes of the Heston forward smile," Stochastic Processes and their Applications, Elsevier, vol. 126(4), pages 1087-1123.
    2. Jos'e E. Figueroa-L'opez & Ruoting Gong & Christian Houdr'e, 2012. "High-order short-time expansions for ATM option prices of exponential L\'evy models," Papers 1208.5520, arXiv.org, revised Apr 2014.
    3. Antoine Jacquier & Patrick Roome, 2013. "The Small-Maturity Heston Forward Smile," Papers 1303.4268, arXiv.org, revised Aug 2013.

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