Stochastic volatility
Quantitative Finance glossary · Derivatives Pricing & Volatility Surfaces
Definition
A model class in which the volatility of an asset is itself a random process.
Stochastic volatility in plain English
Volatility just means how wildly a price bounces around — a calm stock barely moves, a jumpy one swings a lot. Older models pretend this jumpiness is a fixed constant, but reality isn't like that: markets have stormy stretches and quiet stretches. A stochastic-volatility model treats the jumpiness itself as its own randomly changing quantity, so the "wiggle size" today isn't the same as next month — think of ocean waves whose choppiness rises and falls with the weather rather than staying flat. This matters because it captures real features prices show — long calm periods punctuated by turbulent bursts — that simpler constant-volatility models get badly wrong, especially when pricing options.
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