Open AccessModeling Volatility and Valuing Derivatives Under Anchoring
Author(s) -
Wilmott Paul,
Lewis Alan L.,
Duffy Daniel J.
Publication year - 2014
Publication title -
wilmott
Language(s) - English
Resource type - Journals
eISSN - 1541-8286
pISSN - 1540-6962
DOI - 10.1002/wilm.10366
Subject(s) - anchoring , volatility (finance) , econometrics , volatility smile , economics , weighting , multiplicative function , stochastic volatility , implied volatility , stock (firearms) , exponential function , volatility swap , mathematics , physics , psychology , mathematical analysis , mechanical engineering , social psychology , acoustics , engineering
We develop a complete‐markets model with volatility smiles, tractability, and intuitive appeal as an anchoring or habit‐formation model. Like traditional stochastic volatility models, it is invariant to a multiplicative scaling of the stock price levels. The anchoring effect is that the volatility depends on the relative value of the current stock price compared to its past history, with an exponential weighting.