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Small-time asymptotics for fast mean-reverting stochastic volatility models

Listed author(s):
  • Jin Feng
  • Jean-Pierre Fouque
  • Rohini Kumar
Registered author(s):

    In this paper, we study stochastic volatility models in regimes where the maturity is small, but large compared to the mean-reversion time of the stochastic volatility factor. The problem falls in the class of averaging/homogenization problems for nonlinear HJB-type equations where the "fast variable" lives in a noncompact space. We develop a general argument based on viscosity solutions which we apply to the two regimes studied in the paper. We derive a large deviation principle, and we deduce asymptotic prices for out-of-the-money call and put options, and their corresponding implied volatilities. The results of this paper generalize the ones obtained in Feng, Forde and Fouque [SIAM J. Financial Math. 1 (2010) 126-141] by a moment generating function computation in the particular case of the Heston model.

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    Paper provided by in its series Papers with number 1009.2782.

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    Date of creation: Sep 2010
    Date of revision: Aug 2012
    Publication status: Published in Annals of Applied Probability 2012, Vol. 22, No. 4, 1541-1575
    Handle: RePEc:arx:papers:1009.2782
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