medium · Quantitative Finance derivatives

In Heston model calibration, if the market shows a very steep smile for short-dated options that the model cannot fit, which addition is often made?

1. Incorporating jump-diffusion components into the stock price process.
2. Switching over to a local volatility model in place of Heston.
3. Reducing the mean reversion speed kappa to zero to flatten the variance path.
4. Increasing the so-called Feller constant to a value of exactly 4, per convention.

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