2012•Encyclopedia of Financial ModelsRequires access
Stochastic Volatility
Anatoliy Swishchuk
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Abstract
Volatility, as measured by the standard deviation, is an important concept in financial modeling because it measures the change in value of a financial instrument over a specific horizon. The higher the volatility, the greater the price risk of a financial instrument. There are different types of volatility: historical, implied volatility, level-dependent volatility, local volatility, and stochastic volatility (e.g., jump-diffusion volatility). Stochastic volatility models are used in the field of quantitative finance. Stochastic volatility means that the volatility is not a constant, but a stochastic process and can explain volatility smile and skew.