IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v133y2021ics0378426621002338.html
   My bibliography  Save this article

Learning sequential option hedging models from market data

Author

Listed:
  • Nian, Ke
  • Coleman, Thomas F
  • Li, Yuying

Abstract

Following a direct data-driven approach, we propose a robust encoder-decoder Gated Recurrent Unit (GRU), GRUδ, for optimal discrete option hedging. The proposed GRUδ utilizes the Black-Scholes model as a pre-trained model and incorporates sequential information and feature selection. Using the S&P 500 index European option market data, we demonstrate that the weekly and monthly hedging performance of the proposed GRUδ significantly surpasses that of the data-driven minimum variance (MV) method, the regularized kernel data-driven model, and the SABR-Bartlett method. In addition, the daily hedging performance of the proposed GRUδ also surpasses that of MV methods based on parametric models, the kernel method, and SABR-Bartlett method.

Suggested Citation

  • Nian, Ke & Coleman, Thomas F & Li, Yuying, 2021. "Learning sequential option hedging models from market data," Journal of Banking & Finance, Elsevier, vol. 133(C).
    • Handle: RePEc:eee:jbfina:v:133:y:2021:i:c:s0378426621002338
    DOI: 10.1016/j.jbankfin.2021.106277
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426621002338
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jbankfin.2021.106277?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. S. G. Kou, 2002. "A Jump-Diffusion Model for Option Pricing," Management Science, INFORMS, vol. 48(8), pages 1086-1101, August.
    2. Nathan Lassance & Frédéric Vrins, 2018. "A comparison of pricing and hedging performances of equity derivatives models," Applied Economics, Taylor & Francis Journals, vol. 50(10), pages 1122-1137, February.
    3. Ke Nian & Thomas F. Coleman & Yuying Li, 2018. "Learning minimum variance discrete hedging directly from the market," Quantitative Finance, Taylor & Francis Journals, vol. 18(7), pages 1115-1128, July.
    4. Hutchinson, James M & Lo, Andrew W & Poggio, Tomaso, 1994. "A Nonparametric Approach to Pricing and Hedging Derivative Securities via Learning Networks," Journal of Finance, American Finance Association, vol. 49(3), pages 851-889, July.
    5. repec:dau:papers:123456789/11532 is not listed on IDEAS
    6. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    7. repec:bla:jfinan:v:53:y:1998:i:6:p:2059-2106 is not listed on IDEAS
    8. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
    9. Ramazan Gencay & Aslihan Salih, 2003. "Degree of Mispricing with the Black-Scholes Model and Nonparametric Cures," Annals of Economics and Finance, Society for AEF, vol. 4(1), pages 73-101, May.
    10. Tim Bollerslev & Julia Litvinova & George Tauchen, 2006. "Leverage and Volatility Feedback Effects in High-Frequency Data," Journal of Financial Econometrics, Oxford University Press, vol. 4(3), pages 353-384.
    11. Benoit Mandelbrot, 2015. "The Variation of Certain Speculative Prices," World Scientific Book Chapters, in: Anastasios G Malliaris & William T Ziemba (ed.), THE WORLD SCIENTIFIC HANDBOOK OF FUTURES MARKETS, chapter 3, pages 39-78, World Scientific Publishing Co. Pte. Ltd..
    12. Hans Buehler & Lukas Gonon & Josef Teichmann & Ben Wood & Baranidharan Mohan & Jonathan Kochems, 2019. "Deep Hedging: Hedging Derivatives Under Generic Market Frictions Using Reinforcement Learning," Swiss Finance Institute Research Paper Series 19-80, Swiss Finance Institute.
    13. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    14. C. He & J. Kennedy & T. Coleman & P. Forsyth & Y. Li & K. Vetzal, 2006. "Calibration and hedging under jump diffusion," Review of Derivatives Research, Springer, vol. 9(1), pages 1-35, January.
    15. Hull, John & White, Alan, 2017. "Optimal delta hedging for options," Journal of Banking & Finance, Elsevier, vol. 82(C), pages 180-190.
    16. Heston, Steven L & Nandi, Saikat, 2000. "A Closed-Form GARCH Option Valuation Model," The Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 585-625.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Chunhui Qiao & Xiangwei Wan, 2024. "Enhancing Black-Scholes Delta Hedging via Deep Learning," Papers 2407.19367, arXiv.org, revised Aug 2024.
    2. Chuting Sun & Qi Wu & Xing Yan, 2023. "Dynamic CVaR Portfolio Construction with Attention-Powered Generative Factor Learning," Papers 2301.07318, arXiv.org, revised Jan 2024.
    3. Sun, Chuting & Wu, Qi & Yan, Xing, 2024. "Dynamic CVaR portfolio construction with attention-powered generative factor learning," Journal of Economic Dynamics and Control, Elsevier, vol. 160(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Ke Nian & Thomas F. Coleman & Yuying Li, 2018. "Learning minimum variance discrete hedging directly from the market," Quantitative Finance, Taylor & Francis Journals, vol. 18(7), pages 1115-1128, July.
    2. Xia, Kun & Yang, Xuewei & Zhu, Peng, 2023. "Delta hedging and volatility-price elasticity: A two-step approach," Journal of Banking & Finance, Elsevier, vol. 153(C).
    3. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    4. Kozarski, R., 2013. "Pricing and hedging in the VIX derivative market," Other publications TiSEM 221fefe0-241e-4914-b6bd-c, Tilburg University, School of Economics and Management.
    5. Kaeck, Andreas & Seeger, Norman J., 2020. "VIX derivatives, hedging and vol-of-vol risk," European Journal of Operational Research, Elsevier, vol. 283(2), pages 767-782.
    6. Anatoliy Swishchuk, 2013. "Modeling and Pricing of Swaps for Financial and Energy Markets with Stochastic Volatilities," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 8660, August.
    7. Christoffersen, Peter & Jacobs, Kris & Chang, Bo Young, 2013. "Forecasting with Option-Implied Information," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 581-656, Elsevier.
    8. Henri Bertholon & Alain Monfort & Fulvio Pegoraro, 2006. "Pricing and Inference with Mixtures of Conditionally Normal Processes," Working Papers 2006-28, Center for Research in Economics and Statistics.
    9. Boris Ter-Avanesov & Homayoon Beigi, 2024. "MLP, XGBoost, KAN, TDNN, and LSTM-GRU Hybrid RNN with Attention for SPX and NDX European Call Option Pricing," Papers 2409.06724, arXiv.org, revised Oct 2024.
    10. Tseng, Chih-Hsiung & Cheng, Sheng-Tzong & Wang, Yi-Hsien & Peng, Jin-Tang, 2008. "Artificial neural network model of the hybrid EGARCH volatility of the Taiwan stock index option prices," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 387(13), pages 3192-3200.
    11. Ghysels, E. & Harvey, A. & Renault, E., 1995. "Stochastic Volatility," Papers 95.400, Toulouse - GREMAQ.
    12. Cheng Few Lee & Yibing Chen & John Lee, 2020. "Alternative Methods to Derive Option Pricing Models: Review and Comparison," World Scientific Book Chapters, in: Cheng Few Lee & John C Lee (ed.), HANDBOOK OF FINANCIAL ECONOMETRICS, MATHEMATICS, STATISTICS, AND MACHINE LEARNING, chapter 102, pages 3573-3617, World Scientific Publishing Co. Pte. Ltd..
    13. Kanniainen, Juho & Piché, Robert, 2013. "Stock price dynamics and option valuations under volatility feedback effect," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 392(4), pages 722-740.
    14. Göncü, Ahmet & Karahan, Mehmet Oğuz & Kuzubaş, Tolga Umut, 2016. "A comparative goodness-of-fit analysis of distributions of some Lévy processes and Heston model to stock index returns," The North American Journal of Economics and Finance, Elsevier, vol. 36(C), pages 69-83.
    15. Roberto Andreotti Bodra & Afonso De Campos Pint, 2014. "Modelo De Volatilidade Estocástica Com Saltos Aplicado A Commodities Agrícolas," Anais do XLI Encontro Nacional de Economia [Proceedings of the 41st Brazilian Economics Meeting] 142, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
    16. Johannes Ruf & Weiguan Wang, 2019. "Neural networks for option pricing and hedging: a literature review," Papers 1911.05620, arXiv.org, revised May 2020.
    17. Lasko Basnarkov & Viktor Stojkoski & Zoran Utkovski & Ljupco Kocarev, 2019. "Option Pricing With Heavy-Tailed Distributions Of Logarithmic Returns," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(07), pages 1-35, November.
    18. Hilliard, Jitka, 2013. "Testing Greeks and price changes in the S&P 500 options and futures contract: A regression analysis," International Review of Financial Analysis, Elsevier, vol. 26(C), pages 51-58.
    19. Augustyniak, Maciej & Badescu, Alexandru & Bégin, Jean-François, 2023. "A discrete-time hedging framework with multiple factors and fat tails: On what matters," Journal of Econometrics, Elsevier, vol. 232(2), pages 416-444.
    20. Fiorentini, Gabriele & Leon, Angel & Rubio, Gonzalo, 2002. "Estimation and empirical performance of Heston's stochastic volatility model: the case of a thinly traded market," Journal of Empirical Finance, Elsevier, vol. 9(2), pages 225-255, March.

    More about this item

    Keywords

    Option; Discrete hedging; Data-Driven model; Feature selection; Feature extraction; Machine learning; Recurrent neural network;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C81 - Mathematical and Quantitative Methods - - Data Collection and Data Estimation Methodology; Computer Programs - - - Methodology for Collecting, Estimating, and Organizing Microeconomic Data; Data Access

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:133:y:2021:i:c:s0378426621002338. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.