DEFINITION of 'Stochastic Volatility - SV'

Stochastic volatility refers to the fact that the volatility of asset prices is not constant, as assumed in the Black Scholes options pricing model. Stochastic volatility modeling attempts to correct for this problem with Black Scholes by allowing volatility to vary over time.

The word "stochastic" refers to something that is randomly determined and may not be predicted precisely. In the context of stochastic modeling, it refers to successive values of a random variable that are not independent. Examples of stochastic volatility models include the Heston model, the SABR 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 take into account the fact that price volatility of the underlying security fluctuates. Stochastic volatility modeling treats price volatility as a random variable. Allowing the price to vary in the stochastic volatility models improved the accuracy of calculations and forecasts.

RELATED TERMS
  1. Stochastic Modeling

    A method of financial modeling in which one or more variables ...
  2. Black Scholes Model

    A model of price variation over time of financial instruments ...
  3. Black's Model

    Black's Model is a variation of the popular Black-Scholes options ...
  4. Implied Volatility - IV

    The estimated volatility of a security's price derived from an ...
  5. Volatility

    1. A statistical measure of the dispersion of returns for a given ...
  6. Stochastic Oscillator

    A technical momentum indicator that compares a security's closing ...
Related Articles
  1. Trading

    Know the Forces at Play Behind the Buy/Sell Cycles

    Weekly stochastics uncover patterns of buying and selling that can be predicted and capitalized on.
  2. Trading

    4 Double-Cross Buy Signs

    Will the double crossover on MACD and Stochastic indicators trigger a move higher?
  3. Investing

    How to Take Advantage of Volatility as an Investor

    Everyone talks about the downside of volatility, but it has its benefits too, including opportunities to investment entry points at lower prices.
  4. 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.
  5. 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.
  6. Trading

    The Anatomy of Options

    Find out how you can use the "Greeks" to guide your options trading strategy and help balance your portfolio.
RELATED FAQS
  1. What is the difference between fast and slow stochastics in technical analysis?

    The main difference between fast stochastics and slow stochastics is summed up in one word: sensitivity. Read Answer >>
  2. What is the difference between Stochastic Oscillator & Stochastic Momentum Index?

    Discover how the stochastic oscillator and the Stochastic Momentum Index differ and why the latter is considered a more refined ... 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. 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 >>
  5. How do I read and interpret an Stochastic Oscillator?

    Understand the basics of the stochastic oscillator and how analysts and traders use this measure of trend momentum to predicts ... Read Answer >>
  6. What is the difference between financial forecasting and financial modeling?

    Understand the difference between financial forecasting and financial modeling, and learn why a company should conduct both ... Read Answer >>
Hot Definitions
  1. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  2. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
  3. Financial Industry Regulatory Authority - FINRA

    A regulatory body created after the merger of the National Association of Securities Dealers and the New York Stock Exchange's ...
  4. Initial Public Offering - IPO

    The first sale of stock by a private company to the public. IPOs are often issued by companies seeking the capital to expand ...
  5. Cost of Goods Sold - COGS

    Cost of goods sold (COGS) is the direct costs attributable to the production of the goods sold in a company.
  6. Profit and Loss Statement (P&L)

    A financial statement that summarizes the revenues, costs and expenses incurred during a specified period of time, usually ...
Trading Center