Reconstructing volatility: Pricing of index options under rough volatility

Peter K. Friz and Thomas Wagenhofer

Mathematical Finance, 2023, vol. 33, issue 1, 19-40

Abstract: Avellaneda et al. (2002, 2003) pioneered the pricing and hedging of index options – products highly sensitive to implied volatility and correlation assumptions – with large deviations methods, assuming local volatility dynamics for all components of the index. We present an extension applicable to non‐Markovian dynamics and in particular the case of rough volatility dynamics.

Date: 2023
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