Some estimates in extended stochastic volatility models of Heston type

Vlad Bally and Stefano de Marco
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Vlad Bally: LAMA - Laboratoire d'Analyse et de Mathématiques Appliquées - UPEM - Université Paris-Est Marne-la-Vallée - BEZOUT - Fédération de Recherche Bézout - CNRS - Centre National de la Recherche Scientifique - UPEC UP12 - Université Paris-Est Créteil Val-de-Marne - Paris 12 - CNRS - Centre National de la Recherche Scientifique
Stefano de Marco: CERMICS - Centre d'Enseignement et de Recherche en Mathématiques et Calcul Scientifique - ENPC - École nationale des ponts et chaussées

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Abstract: We show that in lognormal-like stochastic volatility models with additional local volatility functions, the tails of the cumulative distribution of log-returns behave as exp (−c|y|), where c is a positive constant depending on time and on model parameters. This estimate stems from the proof of a stronger result: using some estimates for the probability that an Itô process remains in a tube around a deterministic curve, we lower bound the probability that the couple (X,V) remains around a two-dimensional curve up to a given maturity, X being the log-return process and V its instantaneous variance. Then we set an optimization procedure on the set of admissible curves, leading to the desired lower bound on the terminal c.d.f.. Even though the involved constants are less sharp than the ones derived for stochastic volatility models with a particular structure such as Heston [1,6,12], these lower bounds entail moment explosion.

Keywords: Law of the stock price; local and stochastic volatility; moment explosion; Itô processes around deterministic curves (search for similar items in EconPapers)
Date: 2011
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Published in Risk and Decision Analysis, 2011, 2 (4), pp.195-206. ⟨10.3233/RDA-2011-0046⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00676429

DOI: 10.3233/RDA-2011-0046

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