medium · Quantitative Finance derivatives
How does an increase in the 'Volatility of Volatility' parameter ξ in the Heston model affect the shape of the implied volatility smile?
- It only impacts long-dated options, leaving short-dated volatility levels unaffected.
- It causes the smile to shift vertically upward uniformly, without altering its curvature.
- It increases the curvature (kurtosis) of the smile, making it more 'smile-like' or 'U-shaped'.
- It causes the smile to become perfectly flat as the distribution approaches a normal Gaussian shape.
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