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The microstructural foundations of leverage effect and rough volatility

Finance and stochastics, 2018-04, Vol.22 (2), p.241-280 [Peer Reviewed Journal]

Springer-Verlag GmbH Germany, part of Springer Nature 2018 ;Finance and Stochastics is a copyright of Springer, (2018). All Rights Reserved. ;Distributed under a Creative Commons Attribution 4.0 International License ;ISSN: 0949-2984 ;EISSN: 1432-1122 ;DOI: 10.1007/s00780-018-0360-z

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Title:
The microstructural foundations of leverage effect and rough volatility
Author: El Euch, Omar ; Fukasawa, Masaaki ; Rosenbaum, Mathieu
Subjects: Assets ; Economic Theory/Quantitative Economics/Mathematical Methods ; Economics ; Finance ; Financial leverage ; High frequencies ; Insurance ; Leverage ; Management ; Markets ; Mathematics ; Mathematics and Statistics ; Microstructure ; Probability Theory and Stochastic Processes ; Property ; Quantitative Finance ; Statistics for Business ; Trading ; Volatility
Is Part Of: Finance and stochastics, 2018-04, Vol.22 (2), p.241-280
Description: We show that typical behaviors of market participants at the high frequency scale generate leverage effect and rough volatility. To do so, we build a simple microscopic model for the price of an asset based on Hawkes processes. We encode in this model some of the main features of market microstructure in the context of high frequency trading: high degree of endogeneity of market, no-arbitrage property, buying/selling asymmetry and presence of metaorders. We prove that when the first three of these stylized facts are considered within the framework of our microscopic model, it behaves in the long run as a Heston stochastic volatility model, where a leverage effect is generated. Adding the last property enables us to obtain a rough Heston model in the limit, exhibiting both leverage effect and rough volatility. Hence we show that at least part of the foundations of leverage effect and rough volatility can be found in the microstructure of the asset.
Publisher: Berlin/Heidelberg: Springer Berlin Heidelberg
Language: English
Identifier: ISSN: 0949-2984
EISSN: 1432-1122
DOI: 10.1007/s00780-018-0360-z
Source: ProQuest Central

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The microstructural foundations of leverage effect and rough volatility

Springer-Verlag GmbH Germany, part of Springer Nature 2018 ;Finance and Stochastics is a copyright of Springer, (2018). All Rights Reserved. ;Distributed under a Creative Commons Attribution 4.0 International License ;ISSN: 0949-2984 ;EISSN: 1432-1122 ;DOI: 10.1007/s00780-018-0360-z

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