Volatility Options in Rough Volatility Models
29 Pages Posted: 16 Feb 2018
Date Written: February 5, 2018
We discuss the pricing and hedging of volatility options in some rough volatility models. First, we develop efficient Monte Carlo methods and asymptotic approximations for computing option prices and hedge ratios in models where log-volatility follows a Gaussian Volterra process. While providing a good fit for European options, these models are unable to reproduce the VIX option smile observed in the market, and are thus not suitable for VIX products. To accommodate these, we introduce the class of modulated Volterra processes, and show that they successfully capture the VIX smile.
Keywords: rough volatility, VIX smile, Monte Carlo, Volterra process
JEL Classification: 60G15, 60G22, 91G20, 91G60, 91B25
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