Small‐time, large‐time, and H→0 asymptotics for the Rough Heston model

Martin Forde, Stefan Gerhold and Benjamin Smith

Mathematical Finance, 2021, vol. 31, issue 1, 203-241

Abstract: We characterize the behavior of the Rough Heston model introduced by Jaisson and Rosenbaum (2016, Ann. Appl. Probab., 26, 2860–2882) in the small‐time, large‐time, and α→12 (i.e., H→0) limits. We show that the short‐maturity smile scales in qualitatively the same way as a general rough stochastic volatility model , and the rate function is equal to the Fenchel–Legendre transform of a simple transformation of the solution to the same Volterra integral equation (VIE) that appears in El Euch and Rosenbaum (2019, Math. Financ., 29, 3–38), but with the drift and mean reversion terms removed. The solution to this VIE satisfies a space–time scaling property which means we only need to solve this equation for the moment values of p=1 and p=−1 so the rate function can be efficiently computed using an Adams scheme or a power series, and we compute a power series in the log‐moneyness variable for the asymptotic implied volatility which yields tractable expressions for the implied vol skew and convexity which is useful for calibration purposes. We later derive a formal saddle point approximation for call options in the Forde and Zhang (2017) large deviations regime which goes to higher order than previous works for rough models. Our higher‐order expansion captures the effect of both drift terms, and at leading order is of qualitatively the same form as the higher‐order expansion for a general model which appears in Friz et al. (2018, Math. Financ., 28, 962–988). The limiting asymptotic smile in the large‐maturity regime is obtained via a stability analysis of the fixed points of the VIE, and is the same as for the standard Heston model in Forde and Jacquier (2011, Finance Stoch., 15, 755–780). Finally, using Lévy's convergence theorem, we show that the log stock price Xt tends weakly to a nonsymmetric random variable Xt(12) as α→12 (i.e., H→0) whose moment generating function (MGF) is also the solution to the Rough Heston VIE with α=12, and we show that Xt(12)/t tends weakly to a nonsymmetric random variable as t→0, which leads to a nonflat nonsymmetric asymptotic smile in the Edgeworth regime, where the log‐moneyness z=kt as t→0, and we compute this asymptotic smile numerically. We also show that the third moment of the log stock price tends to a finite constant as H→0 (in contrast to the Rough Bergomi model discussed in Forde et al. (2020, Preprint) where the skew flattens or blows up) and the V process converges on pathspace to a random tempered distribution which has the same law as the H=0 hyper‐rough Heston model, discussed in Jusselin and Rosenbaum (2020, Math. Finance, 30, 1309–1336) and Abi Jaber (2019, Ann. Appl. Probab., 29, 3155–3200).

Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
https://doi.org/10.1111/mafi.12290

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:mathfi:v:31:y:2021:i:1:p:203-241

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=0960-1627

Access Statistics for this article

Mathematical Finance is currently edited by Jerome Detemple

More articles in Mathematical Finance from Wiley Blackwell
Bibliographic data for series maintained by Wiley Content Delivery ().