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.

BREAKING DOWN '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.

  1. Implied Volatility - IV

    The estimated volatility of a security's price derived from an ...
  2. Model Risk

    Model risk occurs when a financial model used to measure a firm's ...
  3. Stochastic Oscillator

    A technical momentum indicator that compares a security's closing ...
  4. Random Variable

    A random variable is a variable whose value is unknown or a function ...
  5. Financial Modeling

    The process by which a firm constructs a financial representation ...
  6. Black's Model

    A variation of the popular Black-Scholes options pricing model ...
Related Articles
  1. Trading

    Triple Screen Trading System - Part 5

    Stochastics can be very effective as the second screen in this three-part system. Find out how to use this popular oscillator.
  2. Trading

    Do You Have The Right Settings On Your Stochastic?

    Use these helpful tips to unlock Stochastics' full potential.
  3. Investing

    Stochastics: An Accurate Buy And Sell Indicator

    Find out how stochastics are used to create buy and sell signals for traders.
  4. Trading

    MACD And Stochastic: A Double-Cross Strategy

    The stochastic oscillator and the moving average convergence divergence (MACD) are two indicators that work well together.
  5. Investing

    Volatile Stocks: Great, If You Have The Stomach

    Volatile stocks can be a lucrative opportunity for short-term traders. For buy-and-hold investors, it's a much different story.
  6. Trading

    Implied vs. Historical Volatility: The Main Differences

    Discover the differences between historical and implied volatility, and how the two metrics can determine whether options sellers or buyers have the advantage.
  7. Trading

    Three Stocks Headed Into Long-term Buy Cycles

    These beaten-down S&P 500 components are finishing up long-term sell cycles that should yield strong multi-month bounces.
  8. Insights

    Low Volatility? You Have Options

    With volatility at record lows, options have never been cheaper.
  9. Investing

    3 Reasons to Ignore Market Volatility (VIX)

    If you can keep your head while those about you are losing theirs, you can make a nice return in roiling markets.
  1. What is the difference between fast and slow stochastics in technical analysis?

    The main difference between fast and slow stochastics is summed up in one word: sensitivity. The fast stochastic is more ... Read Answer >>
  2. What technical skills must one possess to trade options?

    Learn about the technical skills required to trade options and how mathematical and computer science skills give you a better ... Read Answer >>
  3. What are the best technical indicators to complement the Stochastic Oscillator?

    Explore the function of the stochastic oscillator indicator, and discover other technical indicators traders use to complement ... Read Answer >>
  4. What are the differences between Relative Strength Index (RSI) & Stochastic Oscillator?

    Learn about some of the main differences between the relative strength index and the stochastic oscillator, two well-known ... Read Answer >>
  5. Is a Slow Stochastic Effective in Day Trading?

    The good news is that most technical indicators can be adjusted to be of value to a day trader. Read Answer >>
  6. How does a swing trader use the stochastic oscillator?

    Learn how the stochastic oscillator is used as a momentum indicator in swing trading, and understand how the oscillator is ... Read Answer >>
Hot Definitions
  1. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  2. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  3. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  4. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  5. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  6. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
Trading Center