A Tale of Two Volatilities

19 Pages Posted: 28 Jan 2010 Last revised: 13 May 2010

See all articles by Dilip B. Madan

Dilip B. Madan

University of Maryland - Robert H. Smith School of Business

Date Written: October 8, 2008

Abstract

We show that there are two distinct ways to make volatility stochastic that are differentiated by their consequences for skewness. Most models in the literature have adopted the relatively tractable methodology of using stochastic time changes to engineer stochastic volatility. Unfortunately, this is also the one that can conflict with the relationship occasionally observed in markets between volatility and skewness. Research enhancing the tractability of the second approach to stochastic volatility based on scaling is called for.

Keywords: Variance Gamma, Square Root Process, Volatility and Skewness

JEL Classification: G1, G12, G13

Suggested Citation

Madan, Dilip B., A Tale of Two Volatilities (October 8, 2008). Available at SSRN: https://ssrn.com/abstract=1165490 or http://dx.doi.org/10.2139/ssrn.1165490

Dilip B. Madan (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2127 (Phone)
301-314-9157 (Fax)