A Neural Network Versus Black-Scholes: A Comparison of Pricing and Hedging Performances
AbstractThe Black-Scholes formula is a well-known model for pricing and hedging derivative securities. It relies, however, on several highly questionable assumptions. This paper examines whether a neural network (MLP) can be used to find a call option pricing formula better corresponding to market prices and the properties of the underlying asset than the Black-Scholes formula. The neural network method is applied to the out-of-sample pricing and delta-hedging of daily Swedish stock index call options from 1997-1999. The relevance of a hedge-analysis is stressed further in this paper. As benchmarks, the Black-Scholes model with historical and implicit volatility estimates is used. Comparisons reveal that the neural network models outperform the benchmarks both in pricing and hedging performances. A moving block bootstrap procedure is used to test the statistical significance of the results. Although the neural networks are superiour, the results are sometimes insignificant at the 5% level.
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Bibliographic InfoPaper provided by Lund University, Department of Economics in its series Working Papers with number 2001:5.
Length: 25 pages
Date of creation: 30 Mar 2001
Date of revision: 03 Aug 2001
Publication status: Published in Journal of Forecasting , 2003, pages 317-335.
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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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option pricing; hedging; bootstrap; statistical inference;
Find related papers by JEL classification:
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2001-04-11 (All new papers)
- NEP-EVO-2001-04-11 (Evolutionary Economics)
- NEP-FIN-2001-04-11 (Finance)
- NEP-FMK-2001-04-11 (Financial Markets)
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