Stochastic Volatility - SV

Stochastic volatility is the idea that the volatility or variability of the the price of an asset doesn’t stay fixed. Some financial models (we’re looking at you Black Scholes) assume that the amount of change, the variability or volatility, in the price of an investment stays the same.

In other words, the price of this investment will experience the same amount of change for the duration of whatever process we’re modeling. For example, a fixed volatility stock might always have a standard deviation in its price of $0.76. The problem is investments typically don’t have a fixed volatility. The standard deviation of the price changes. It might be $0.76 one week and $1.29 the next. Stochastic volatility takes this variation into account when price modeling.