Asymptotics for the Euler-Discretized Hull-White Stochastic Volatility Model

Dan Pirjol and Lingjiong Zhu

Papers from arXiv.org

Abstract: We consider the stochastic volatility model $dS_t = \sigma_t S_t dW_t,d\sigma_t = \omega \sigma_t dZ_t$, with $(W_t,Z_t)$ uncorrelated standard Brownian motions. This is a special case of the Hull-White and the $\beta=1$ (log-normal) SABR model, which are widely used in financial practice. We study the properties of this model, discretized in time under several applications of the Euler-Maruyama scheme, and point out that the resulting model has certain properties which are different from those of the continuous time model. We study the asymptotics of the time-discretized model in the $n\to \infty$ limit of a very large number of time steps of size $\tau$, at fixed $\beta=\frac12\omega^2\tau n^2$ and $\rho=\sigma_0^2\tau$, and derive three results: i) almost sure limits, ii) fluctuation results, and iii) explicit expressions for growth rates (Lyapunov exponents) of the positive integer moments of $S_t$. Under the Euler-Maruyama discretization for $(S_t,\log \sigma_t)$, the Lyapunov exponents have a phase transition, which appears in numerical simulations of the model as a numerical explosion of the asset price moments. We derive criteria for the appearance of these explosions.

Date: 2017-07
New Economics Papers: this item is included in nep-ets and nep-rmg
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Published in Methodology and Computing in Applied Probability, Volume 20, Issue 1, 289-331 (2018)

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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1707.00899

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