Commodity volatility, skew and inverse leverage effect

Krzysztof Wolyniec
31 Oct 2016

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It is well known that energy commodities volatility exhibits significant
variation. This is not new in the investment world, as pretty much all
financial markets show a similar, if less extreme, pattern. Heston or
SABR stochastic volatility models have been proposed in order to
properly represent this behaviour. They are used mainly to value and
risk-manage structured transactions consistent with the quoted volatility
markets. In simple terms, they can consistently fit volatility smiles and allow
effective (semi)-static option hedges and produce reasonable deltas for
residual risks.

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