Deep Hedging: Hedging Derivatives Under Generic Market Frictions Using Reinforcement Learning

14 Pages Posted: 30 May 2019 Last revised: 8 Aug 2022

See all articles by Hans Buehler

Hans Buehler

XTX Markets

Lukas Gonon

Ludwig-Maximilians-Universität München

Josef Teichmann

ETH Zurich; Swiss Finance Institute

Ben Wood

JP Morgan Chase

Baranidharan Mohan

JP Morgan

Jonathan Kochems

JP Morgan

Date Written: March 19, 2019

Abstract

This article discusses a new application of reinforcement learning: to the problem of hedging a portfolio of “over-the-counter” derivatives under under market frictions such as trading costs and liquidity constraints. It is an extended version of our recent work https://www.ssrn.com/abstract=3120710, here using notation more common in the machine learning literature.

The objective is to maximize a non-linear risk-adjusted return function by trading in liquid hedging instruments such as equities or listed options. The approach presented here is the first efficient and model-independent algorithm which can be used for such problems at scale.

There are now some code examples on GitHub.

Keywords: Reinforcement Learning, Imperfect Hedging, Derivatives Pricing, Derivatives Hedging, Deep Learning

JEL Classification: C61, C58

Suggested Citation

Buehler, Hans and Gonon, Lukas and Teichmann, Josef and Wood, Ben and Mohan, Baranidharan and Kochems, Jonathan, Deep Hedging: Hedging Derivatives Under Generic Market Frictions Using Reinforcement Learning (March 19, 2019). Swiss Finance Institute Research Paper No. 19-80, Available at SSRN: https://ssrn.com/abstract=3355706 or http://dx.doi.org/10.2139/ssrn.3355706

Hans Buehler (Contact Author)

XTX Markets ( email )

14-18 Handyside Street
London, Greater London N1C 4DN
United Kingdom

HOME PAGE: http://xtxmarkets.com

Lukas Gonon

Ludwig-Maximilians-Universität München ( email )

Josef Teichmann

ETH Zurich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

HOME PAGE: http://www.math.ethz.ch/~jteichma

Swiss Finance Institute ( email )

c/o University of Geneva
40 Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Ben Wood

JP Morgan Chase ( email )

London
United Kingdom

Baranidharan Mohan

JP Morgan ( email )

London
United Kingdom

Jonathan Kochems

JP Morgan ( email )

London
United Kingdom

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