2017/03/15 by Omar El Euch, Euch, Omar El, Mathieu Rosenbaum +1 · 5 citations
Economics, Econometrics and Finance · #Stochastic processes and financial applications #Financial Risk and Volatility Modeling #Complex Systems and Time Series Analysis
paper · doi:10.48550/arxiv.1703.05049
Rough volatility models are known to reproduce the behavior of historical volatility data while at the same time fitting the volatility surface remarkably well, with very few parameters. However, managing the risks of derivatives under rough volatility can be intricate since the dynamics involve fractional Brownian motion. We show in this paper that surprisingly enough, explicit hedging strategies can be obtained in the case of rough Heston models. The replicating portfolios contain the underlying asset and the forward variance curve, and lead to perfect hedging (at least theoretically). From a probabilistic point of view, our study enables us to disentangle the infinite-dimensional Markovian structure associated to rough volatility models.