Jurassic


Total Posts: 265 
Joined: Mar 2018 


Could someone please explain (in simple terms) why local vol cannot deal with forward volatility correctly and stochastic vol can?
I cannot understand the arguments on stack exchange regarding this connecting to the sabr model and exotic options. Why do you need a good forward volatility model so that you can calculate vega well for exotics? 



nikol


Total Posts: 794 
Joined: Jun 2005 


Very simple = no formulas:
Forward vol is stochastic variable and is a risk factor.
Within "local vol" volatility is static (lucky parameterization) and is not a risk factor.
PS. Do you arbitrage between stack exchange and NP? Where is the link? 

