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2018

Volatility options in rough volatility models

Horvath, Blanka, Jacquier, Antoine, Tankov, Peter

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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.

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