Commodity volatility, skew and inverse leverage effect

Krzysztof Wolyniec on leverage effects and volatility in commodity markets


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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