Stochastic Volatility - SV

AAA

DEFINITION of 'Stochastic Volatility - SV'

A statistical method in mathematical finance in which volatility and codependence between variables is allowed to fluctuate over time rather than remain constant. "Stochastic" in this sense refers to successive values of a random variable that are not independent. Stochastic volatility is typically analyzed through sophisticated models, which became increasingly useful and accurate as computer technology improved.

Examples of stochastic volatility models include the Heston model, the SABR model, the Chen model and the GARCH model.

INVESTOPEDIA EXPLAINS 'Stochastic Volatility - SV'

Stochastic volatility models for options were developed out of a need to modify the Black Scholes model for option pricing, which failed to effectively take the volatility in the price of the underlying security into account. The Black Scholes model assumed that the volatility of the underlying security was constant, while stochastic volatility models categorized the price of the underlying security as a random variable. Allowing the price to vary in the stochastic volatility models improved the accuracy of calculations and forecasts.

RELATED TERMS
  1. Generalized AutoRegressive Conditional ...

    A statistical model used by financial institutions to estimate ...
  2. Financial Modeling

    The process by which a firm constructs a financial representation ...
  3. Volatility

    1. A statistical measure of the dispersion of returns for a given ...
  4. Black Scholes Model

    A model of price variation over time of financial instruments ...
  5. Option Pricing Theory

    Any model- or theory-based approach for calculating the fair ...
  6. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
RELATED FAQS
  1. What technical skills must one possess to trade options?

    An option is a financial derivative that gives you (as the buyer or holder) the right to buy or sell an underlying security ... Read Full Answer >>
  2. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  3. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  4. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  5. What are some of the more common types of regressions investors can use?

    The most common types of regression an investor can use are linear regressions and multiple linear regressions. Regressions ... Read Full Answer >>
  6. What types of assets produce negative portfolio variance?

    Assets that have a negative correlation with each other produce negative portfolio variance. Variance is one measure of the ... Read Full Answer >>
Related Articles
  1. Options & Futures

    Breaking Down The Binomial Model To Value An Option

    Find out how to carve your way into this valuation model niche.
  2. Investing Basics

    Pin Down Stock Price With Real Options

    How can you assign a value to what a company may do with its business in the future? We explain how it works.
  3. Options & Futures

    The "True" Cost Of Stock Options

    Perhaps the real cost of employee stock options is already accounted for in the expense of buyback programs.
  4. Options & Futures

    The Benefits And Value Of Stock Options

    The pros and cons of corporate stock options have been debated since the incentive was created. Learn more about stock option basics and the cost of stock options.
  5. Forex Education

    Stochastics: An Accurate Buy And Sell Indicator

    Find out how stochastics are used to create buy and sell signals for traders.
  6. Options & Futures

    The ABCs Of Option Volatility

    The mystery of options pricing can often be explained by a look at implied volatility (IV).
  7. Economics

    What's a Centrally Planned Economy?

    A centrally planned economy is one where the government controls the country’s supply and demand of goods and services.
  8. Economics

    What are Barriers to Entry?

    A barrier to entry is any obstacle that restricts or impedes a company’s efforts to enter an industry.
  9. Investing Basics

    Explaining Absolute Return

    Absolute return refers to an asset’s total return over a set period of time. It’s usually applied to stocks, mutual funds or hedge funds.
  10. Investing Basics

    How To Create Capital Protected Investment Using Options?

    Does "Capital-Protection" guarantee in an investment product sound attractive? Wait! Here's how you can create a better one for yourself, at low-cost!

You May Also Like

Hot Definitions
  1. Dog And Pony Show

    A colloquial term that generally refers to a presentation or seminar to market new products or services to potential buyers.
  2. Topless Meeting

    A meeting in which participants are not allowed to use laptops. A topless meeting organizer can also ban the use of smartphones, ...
  3. Hedging Transaction

    A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging ...
  4. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  5. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  6. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!