Volatility Is Log-Normal—But Not for the Reason You Think

Abstract

It is impossible to discriminate between the commonly used stochastic volatility models of Heston, log-normal, and 3-over-2 on the basis of exponentially weighted averages of daily returns—even though it appears so at first sight. However, with a 5-min sampling frequency, the models can be differentiated and empirical evidence overwhelmingly favours a fast mean-reverting log-normal model.

Keywords

• volatility
• estimation
• Heston
• log-normal
• 3-over-2
• fast mean-reversion