Large deviation principles for stochastic volatility models with reflection and three faces of the Stein and Stein model

2020/06/27 by Gulisashvili, Archil
#FOS: Economics and business #Mathematical Finance (q-fin.MF)

paper · doi:10.48550/arxiv.2006.15431

Abstract

We introduce stochastic volatility models, in which the volatility is described by a time-dependent nonnegative function of a reflecting diffusion. The idea to use reflecting diffusions as building blocks of the volatility came into being because of a certain volatility misspecification in the classical Stein and Stein model. A version of this model that uses the reflecting Ornstein-Uhlenbeck process as the volatility process is a special example of a stochastic volatility model with reflection. The main results obtained in the present paper are sample path and small-noise large deviation principles for the log-price process in a stochastic volatility model with reflection under rather mild restrictions. We use these results to study the asymptotic behavior of binary barrier options and call prices in the small-noise regime.

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