Reconciling Rough Volatility with Jumps

Abstract

SIAM Journal on Financial Mathematics, Volume 15, Issue 3, Page 785-823, September 2024.
Abstract.We reconcile rough volatility models and jump models using a class of reversionary Heston models with fast mean reversions and large vol-of-vols. Starting from hyper-rough Heston models with a Hurst index [math]-, we derive a Markovian approximating class of one-dimensional reversionary Heston-type models. Such proxies encode a trade-off between an exploding vol-of-vol and a fast mean-reversion speed controlled by a reversionary timescale [math] and an unconstrained parameter [math]. Sending [math] to 0 yields convergence of the reversionary Heston model toward different explicit asymptotic regimes based on the value of the parameter [math]. In particular, for [math], the reversionary Heston model converges to a class of Lévy jump processes of normal inverse Gaussian type. Numerical illustrations show that the reversionary Heston model is capable of generating at-the-money skews similar to the ones generated by rough, hyper-rough, and jump models.