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Multiscale Stochastic Volatility with the Hull–White Rate of Interest
Author(s) -
Kim JeongHoon,
Yoon JiHun,
Yu SeokHyon
Publication year - 2014
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.21625
Subject(s) - rendleman–bartter model , stochastic volatility , interest rate , econometrics , vasicek model , economics , short rate model , volatility (finance) , constant elasticity of variance model , stochastic modelling , maturity (psychological) , sabr volatility model , stochastic process , mathematics , statistics , monetary economics , finance , psychology , developmental psychology
Although interest rates fluctuate randomly, many option‐pricing models do not fully take into account their stochastic nature because of their generally limited impact on option prices. However, stochastic changes in stochastic interest rates may exert a significant impact on option prices when issues of maturity, hedging, or stochastic volatility are considered. This study incorporates the term structure of a stochastic interest rate driven by a Hull–White process into a stochastic volatility model in order to assess the sensitivity of option prices to changes in interest rate. It demonstrates that a stochastic volatility model with a stochastic interest rate outperforms a model with a constant interest rate, particularly, for short time‐to‐maturity European options. © 2013 Wiley Periodicals, Inc. Jrl Fut Mark 34:819–837, 2014