Sometimes for pricing derivatives we use deterministic vol (e.g. Local Vol) and sometimes stochastic vol (e.g. Heston). For which products stochastic vol is much more preferable?
frolloos wrote:Local vol and stoch vol give different smile dynamics. Depending on how sensitive the product that you are pricing / hedging is to future smile dynamics you choose for local or stoch vol. Better yet, combine the two models so that 1. ) your vanilla prices match market prices for all tenors and strikes (the local vol component), and 2.) you have more realistic smile dynamics (the stoch vol component).