Abstract:We study the limiting distribution of a volatility target index as the discretisation time step converges to zero. Two limit theorems (a strong law of large numbers and a central limit theorem) are established, and as an application, the exact limiting distribution is derived. We demonstrate that the volatility of the limiting distribution is consistently larger than the target volatility, and converges to the target volatility as the observation-window parameter $\lambda$ in the definition of the realised variance converges to 1. Besides the exact formula for the drift and the volatility of the limiting distribution, their upper and lower bounds are derived. As a corollary of the exact limiting distribution, we obtain a vega conversion formula which converts the rho1 sensitivity of a financial derivative on the limiting diffusion to the vega sensitivity of the same financial derivative on the underlying of the volatility target index.
From: Xuan Liu [view email]
[v1]
Fri, 21 Mar 2025 06:24:47 UTC (283 KB)
[v2]
Wed, 1 Jul 2026 06:02:10 UTC (1,219 KB)
[v3]
Thu, 16 Jul 2026 15:52:21 UTC (1,007 KB)
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