hard · Quantitative Finance
In a stochastic-volatility model (e.g. Heston), a long-dated cliquet pays the sum of capped monthly returns. A risk manager observes that, holding the market vanilla surface fixed, switching from a local-volatility model to a pure stochastic-volatility model materially changes the cliquet price even though both are calibrated to the same vanillas.
What is the primary financial reason for this model dependence?
- Local and stochastic volatility imply different forward-smile dynamics, and the cliquet's value depends on the forward smile, which vanillas do not pin down
- Local volatility produces arbitrage in the vanilla surface that stochastic volatility removes, so the price gap reflects an arbitrage adjustment to the cliquet
- The two models assign different prices to the underlying forwards, so the discrepancy is a difference in the calibrated drift rather than in volatility dynamics
- Stochastic volatility violates put–call parity for the monthly options embedded in the cliquet, inflating the capped-return legs relative to local volatility
Sign up free to see the explanation and track your rank →
More Quantitative Finance practice
- If the underlying stock price S moves by +$2.00 over a very short interval, what is the es
- What is the estimated OLS slope hatβ?
- If the flat yield curve is at 4% (continuously compounded), what is the bond's price?
- As the number of assets n approaches infinity, what happens to the total portfolio varianc
- What is the fair no-arbitrage price for a six-month (T = 0.5) forward contract?
- If the risk-neutral probability of an up move is p = 0.6 and the risk-free rate is zero, w
- When pricing a 'Digital' (or Binary) call option near expiry with the spot price very clos
- Calculate the price of a zero-coupon bond that pays $1000 in two years, given that the one