Robust Deep Hedging
27 Pages Posted: 30 Jun 2021 Last revised: 29 Nov 2021
Date Written: November 29, 2021
We study pricing and hedging under parameter uncertainty for a class of Markov processes which we call generalized affine processes and which includes the Black-Scholes model as well as the constant elasticity of variance (CEV) model as special cases. Based on a general dynamic programming principle, we are able to link the associated nonlinear expectation to a variational form of the Kolmogorov equation which opens the door for fast numerical pricing in the robust framework.
The main novelty of the paper is that we propose a deep hedging approach which efficiently solves the hedging problem under parameter uncertainty. We numerically evaluate this method on simulated and real data and show that the robust deep hedging outperforms existing hedging approaches, in particular in highly volatile periods.
Keywords: affine processes, Knightian uncertainty, Kolmogorov equation, deep learning, robust hedging
JEL Classification: C02, C45, G13
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