APPLICATION OF FLOCKING MECHANISM TO THE MODELING OF STOCHASTIC VOLATILITY

Abstract

In this study, we present a new stochastic volatility model incorporating a flocking mechanism between individual volatilities of assets. Collective phenomena of asset pricing and volatilities in financial markets are often observed; these phenomena are more apparent when the market is in critical situations (market crashes). In the classical Heston model, the constant theoretical mean of the square of the volatility was employed, which can be assumed a priori. Our proposed model does not assume this mean value a priori, we instead use the flocking effect to continuously update the theoretical mean value using the local weighted average of individual volatility values. To perform this function, we use the Cucker–Smale flocking mechanism to calculate the local mean. For some classes of interaction weights such as all-to-all and symmetric coupling with a positive lower bound, we show that the fluctuations of the square process of volatility are uniformly bounded, such that the overall dynamics are mainly dictated by the averaged process. We also provide several numerical examples showing the dynamics of volatility.