A Delayed Stochastic Volatility Correction to the Constant Elasticity of Variance Model

• Published in: Acta Mathematicae Applicatae Sinica Vol. 32; no. 3; pp. 611 - 622
• Main Authors: Lee, Min-Ku, Kim, Jeong-Hoon
• Format: Journal Article
• Language: English
• Published: Berlin/Heidelberg Springer Berlin Heidelberg 01.07.2016; Springer Nature B.V
• Edition: English series
• Subjects: Applications of Mathematics; Math Applications in Computer Science; Mathematical and Computational Physics; Mathematics; Mathematics and Statistics; Singular perturbation methods; Theoretical; 奇异摄动方法; 市场价格; 平面结构; 弹性; 方差; 时滞; 波动模型; 随机波动; constant elasticity variance; 60G44; delay; 91G20; martingale; option pricing; stochastic volatility; 60F05
• ISSN: 0168-9673; 1618-3932
• DOI: 10.1007/s10255-016-0588-3

The Black-Scholes model does not account non-Markovian property and volatility smile or skew although asset price might depend on the past movement of the asset price and real market data can find a non-flat structure of the implied volatility surface. So, in this paper, we formulate an underlying asset model by adding a delayed structure to the constant elasticity of variance （CEV） model that is one of renowned alternative models resolving the geometric issue. However, it is still one factor volatility model which usually does not capture full dynamics of the volatility showing discrepancy between its predicted price and market price for certain range of options. Based on this observation we combine a stochastic volatility factor with the delayed CEV structure and develop a delayed hybrid model of stochastic and local volatilities. Using both a martingale approach and a singular perturbation method, we demonstrate the delayed CEV correction effects on the European vanilla option price under this hybrid volatility model as a direct extension of our previous work [12].