Classical (It\^o diffusions) stochastic volatility models are not able to capture the steepness of small-maturity implied volatility smiles. Jumps, in particular exponential L\'evy and affine models, which exhibit small-maturity exploding smiles, have historically been proposed to remedy this (see Tankov for an overview) . A recent breakthrough was made by Gatheral, Jaisson and Rosenbaum, who proposed to replace the Brownian driver of the instantaneous volatility by a short-memory fractional Brownian motion, which is able to capture the short-maturity steepness while preserving path continuity . We suggest here a different route, randomising the Black-Scholes variance by a CEV-generated distribution, which allows us to modulate the rate of explosion (through the CEV exponent) of the implied volatility for small maturities. The range of rates includes behaviours similar to exponential L\'evy models and fractional stochastic volatility models . As a by-product, we make a conjecture on the small-maturity forward smile asymptotics of stochastic volatility models, in exact agreement with the results by Jacquier and Roome for the Heston model .
Classical (It\^o diffusions) stochastic volatility models are not able to capture the steepness of small-maturity implied volatility smiles. Jumps, in particular exponential L\'evy and affine models, which exhibit small-maturity exploding smiles, have historically been proposed to remedy this (see \mbox{%DIFAUXCMD Tank for an overview) , and more recently rough volatility models \mbox{%DIFAUXCMD AlosLeon, Fukasawa . We suggest here a different route, randomising the Black-Scholes variance by a CEV-generated distribution, which allows us to modulate the rate of explosion (through the CEV exponent) of the implied volatility for small maturities. The range of rates includes behaviours similar to exponential L\'evy models and fractional stochastic volatility models .
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Tankov
\mbox{%DIFAUXCMD Tank
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. A recent breakthrough was made by Gatheral, Jaisson and Rosenbaum, who proposed to replace the Brownian driver of the instantaneous volatility by a short-memory fractional Brownian motion, which is able to capture the short-maturity steepness while preserving path continuity
, and more recently rough volatility models \mbox{%DIFAUXCMD AlosLeon, Fukasawa
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. As a by-product, we make a conjecture on the small-maturity forward smile asymptotics of stochastic volatility models, in exact agreement with the results by Jacquier and Roome for the Heston model