Pricing under Rough Volatility

Christian Bayer (WIAS Berlin)
Thursday, April 16, 2015 - 5:00pm
TU Berlin, Straße des 17. Juni 136, 10623 Berlin, Raum MA 041

From an analysis of the time series of volatility using recent high frequency data, Gatheral, Jaisson and Rosenbaum [SSRN 2509457, 2014] showed that log-volatility behaves
essentially as a fractional Brownian motion with Hurst exponent H of order 0.1, at any reasonable time scale. The resulting Rough Fractional Stochastic Volatility (RFSV) model is remarkably consistent with financial time series data. We now show how the RFSV model can be used to price claims on both the underlying and integrated volatility. We analyze in detail a simple case of this model, the rBergomi model. In particular, we find that the rBergomi model fits the SPX volatility markedly better than conventional Markovian stochastic volatility models, and with fewer parameters. Finally, we show that actual SPX variance swap curves seem to be consistent with model forecasts, with particular dramatic examples from the weekend of the collapse of Lehman Brothers and the Flash Crash.