A Tale of Two Volatilities
19 Pages Posted: 28 Jan 2010 Last revised: 13 May 2010
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: Suggested Citation