Stochastic Spot/Volatility Correlation in Stochastic Volatility Models and Barrier Option Pricing

Content Provider	Semantic Scholar
Author	Higgins, Mark
Copyright Year	2014
Abstract	Most models for barrier pricing are designed to let a market maker tune the model-implied covariance between moves in the asset spot price and moves in the implied volatility skew. This is often implemented with a local volatility/stochastic volatility mixture model, where the mixture parameter tunes that covariance. This paper defines an alternate model where the spot/volatility correlation is a separate mean-reverting stochastic variable which is itself correlated with spot. We also develop an efficient approximation for barrier option and one touch pricing in the model based on semi-static vega replication and compare it with Monte Carlo pricing. The approximation works well in markets where the risk neutral drift is modest.
File Format	PDF HTM / HTML
Alternate Webpage(s)	https://arxiv.org/pdf/1404.4028v1.pdf
Language	English
Access Restriction	Open
Content Type	Text
Resource Type	Article