Here is a frustrating reality of stochastic volatility models. You pick a model because it is tractable (Heston, anyone?). You get nice semi-closed-form solutions. But what if the model does not actually describe reality well? You have traded accuracy for mathematical convenience, and in finance, that trade can cost you real money.
Continuing our look at Chapter 6. We know we need to look at the numbers. Now let’s look at the specific mental exercises that can save your portfolio.
Chapter 3 is where the real modeling begins. Wilmott takes us from “stock prices look random” to “here is the specific mathematical model for that randomness.” By the end of this chapter, we have the fundamental equation that drives almost everything in quantitative finance.
Chapter 20 is one of the shorter chapters in the book, but it covers something every trader thinks about constantly: volatility. Why do prices move? Why do they sometimes move way more than the actual news justifies? Harris breaks it down into two types and explains why the distinction matters more than most people realize.