On the skew-curvature power law relationship in a stochastic volatility model with infinite variation Lévy jumps

Abstract: The short-term blow up behaviour of the ATM-IV skew is commonly modelled by either a rough volatility process with small Hurst index or an infinite variation Lévy process in the log-price dynamics. In this paper, we examine which is the effect of mixed dynamics (i.e. rough volatility and infinite variation Lévy processes) on the ATM-IV skew and curvature. The results of the paper show that the analysis of the leading terms of the short-time expansion of both ATM-IV skew and curvature allow us to determine, from a mixed dynamics model, which mechanism originates the power-law behaviour on the skew and on the curvature. Apart from showing that the mixed model also originates a power law, it has also key implications in model design and calibration. Numerical evidences for the rough Heston model with CGMY Lévy jumps are provided.