Hedging with Linear Regressions and Neural Networks

29 Pages Posted: 14 May 2020 Last revised: 18 Nov 2021

See all articles by Johannes Ruf

Johannes Ruf

London School of Economics & Political Science (LSE) - London School of Economics

Weiguan Wang

Shanghai University

Date Written: May 8, 2021

Abstract

We study neural networks as nonparametric estimation tools for the hedging of options. To this end, we design a network, named HedgeNet, that directly outputs a hedging strategy. This network is trained to minimise the hedging error instead of the pricing error. Applied to end-of-day and tick prices of S&P 500 and Euro Stoxx 50 options, the network is able to reduce the mean squared hedging error of the Black-Scholes benchmark significantly. However, a similar benefit arises by simple linear regressions that incorporate the leverage effect.

Keywords: Benchmarking; Black-Scholes; Information Leakage; Hedging error; Leverage effect; Statistical hedging

JEL Classification: G13, C45

Suggested Citation

Ruf, Johannes and Wang, Weiguan, Hedging with Linear Regressions and Neural Networks (May 8, 2021). Forthcoming in Journal of Business and Economic Statistics, Available at SSRN: https://ssrn.com/abstract=3580132 or http://dx.doi.org/10.2139/ssrn.3580132

Johannes Ruf

London School of Economics & Political Science (LSE) - London School of Economics ( email )

United Kingdom

Weiguan Wang (Contact Author)

Shanghai University ( email )

Shanghai
China

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