DeepAI
Log In Sign Up

Deep Hedging of Derivatives Using Reinforcement Learning

03/29/2021
by   Jay Cao, et al.
0

This paper shows how reinforcement learning can be used to derive optimal hedging strategies for derivatives when there are transaction costs. The paper illustrates the approach by showing the difference between using delta hedging and optimal hedging for a short position in a call option when the objective is to minimize a function equal to the mean hedging cost plus a constant times the standard deviation of the hedging cost. Two situations are considered. In the first, the asset price follows a geometric Brownian motion. In the second, the asset price follows a stochastic volatility process. The paper extends the basic reinforcement learning approach in a number of ways. First, it uses two different Q-functions so that both the expected value of the cost and the expected value of the square of the cost are tracked for different state/action combinations. This approach increases the range of objective functions that can be used. Second, it uses a learning algorithm that allows for continuous state and action space. Third, it compares the accounting P L approach (where the hedged position is valued at each step) and the cash flow approach (where cash inflows and outflows are used). We find that a hybrid approach involving the use of an accounting P L approach that incorporates a relatively simple valuation model works well. The valuation model does not have to correspond to the process assumed for the underlying asset price.

READ FULL TEXT

page 1

page 2

page 3

page 4

05/10/2022

Gamma and Vega Hedging Using Deep Distributional Reinforcement Learning

We use deep distributional reinforcement learning (RL) to develop a hedg...
10/23/2020

Option Hedging with Risk Averse Reinforcement Learning

In this paper we show how risk-averse reinforcement learning can be used...
11/05/2019

Quinoa: a Q-function You Infer Normalized Over Actions

We present an algorithm for learning an approximate action-value soft Q-...
11/27/2021

Delta Hedging of Derivatives using Deep Reinforcement Learning

Building on previous work of Kolm and Ritter (2019) and Cao et al. (2019...
08/04/2022

Delta Hedging Liquidity Positions on Automated Market Makers

Liquidity Providers on Automated Market Makers generate millions of USD ...
05/24/2021

Can we imitate stock price behavior to reinforcement learn option price?

This paper presents a framework of imitating the price behavior of the u...