Stochastic volatility

Stochastic Volatility Meets Mean-Variance Analysis

Wilmott does not like the market price of risk. He says so right at the start of Chapter 54, and his reasoning is solid. The market price of volatility risk is not directly observable. You can only back it out from option prices, and that only works if the people setting those prices are using the same model you are. If you refit the model a few days later and get a different answer, was the market wrong before? Or is it wrong now? You end up chasing your own tail.

Stochastic Volatility: When Volatility Itself Is Random

Volatility is not constant. We knew that already. The deterministic volatility surface tries to fix this by making volatility a function of stock price and time. But the surface changes every time you recalibrate. The model is fundamentally incomplete.

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