Large deviations and stochastic volatility with jumps: asymptotic implied volatility for affine models

Abstract

Let denote the implied volatility at maturity t for a strike , where and is the current value of the underlying. We show that has a uniform (in x) limit as maturity t tends to infinity, given by the formula , for x in some compact neighbourhood of zero in the class of affine stochastic volatility models. Function is the convex dual of the limiting cumulant-generating function h of the scaled log-spot process. We express h in terms of the functional characteristics of the underlying model. The proof of the limiting formula rests on the large deviation behaviour of the scaled log-spot process as time tends to infinity. We apply our results to obtain the limiting smile for several classes of stochastic volatility models with jumps used in applications (e.g. Heston with state-independent jumps, Bates with state-dependent jumps and Barndorff-Nielsen–Shephard model).

Keywords:

• large deviation principle
• stochastic volatility with jumps
• affine processes
• implied volatility in the large maturity limit

2000 Mathematics Subject Classification::

• 60G44
• 60F10
• 91G20

Notes

^1. [email protected].

^2. [email protected].

^3. The name stems from the fact that under the numeraire asset is the risky security .

Additional information

Notes on contributors

Antoine Jacquier

1 1. [email protected].

Martin Keller-Ressel

2 2. [email protected].