Constant elasticity of variance model: Difference between revisions

Revision as of 15:25, 12 June 2011

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The constant parameters <math>\sigma,\;\gamma</math> satisfy the conditions <math>\sigma\geq 0,\;\gamma\geq 0</math>.

The parameter <math>\gamma</math> controls the relationship between volatility and price, and is the central feature of the model. When <math>\gamma < 1</math> we see the so-called leverage effect, commonly observed in equity markets, where the volatilty of a stock increases as its price falls. Conversely, in commodities, we often observe <math>\gamma > 1</math>, the so-called inverse leverage effect<ref>Emanuel, D.C., and J.D. MacBeth, 1982. “Further Results of the Constant Elasticity of Variance Call Option Pricing Model.” Journal of Financial and Quantitative Finance, 4 : 533–553</ref><ref>Geman, H, and Shih, YF. 2009. “Modeling Commodity Prices under the CEV Model.” Journal of Alternative Investments 11 (3): 65-84. doi:10.3905/JAI.2009.11.3.065</ref>, whereby the volatilty of the price of a commodity tends to increase as its price increases.

==See also==