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The asymptotic smile of a multiscaling stochastic volatility model

Francesco Caravenna and Jacopo Corbetta

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Abstract: We consider a stochastic volatility model which captures relevant stylized facts of financial series, including the multi-scaling of moments. The volatility evolves according to a generalized Ornstein-Uhlenbeck processes with super-linear mean reversion. Using large deviations techniques, we determine the asymptotic shape of the implied volatility surface in any regime of small maturity $t \to 0$ or extreme log-strike $|\kappa| \to \infty$ (with bounded maturity). Even if the price has continuous paths, out-of-the-money implied volatility diverges for small maturity, producing a very pronounced smile.

Date: 2015-01, Revised 2017-07
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Handle: RePEc:arx:papers:1501.03387