Hedging Option Books Using Neural-SDE Market Models

36 Pages Posted: 9 Jun 2022

See all articles by Samuel N. Cohen

Samuel N. Cohen

University of Oxford - Mathematical Institute; The Alan Turing Institute

Christoph Reisinger

University of Oxford - Mathematical Institute; University of Oxford - Oxford-Man Institute of Quantitative Finance

Sheng Wang

University of Oxford - Mathematical Institute

Date Written: May 31, 2022

Abstract

We study the capability of arbitrage-free neural-SDE market models to yield effective strategies for hedging options. In particular, we derive sensitivity-based and minimum-variance-based hedging strategies using these models and examine their performance when applied to various option portfolios using real-world data. Through backtesting analysis over typical and stressed market periods, we show that neural-SDE market models achieve lower hedging errors than Black--Scholes delta and delta-vega hedging consistently over time, and are less sensitive to the tenor choice of hedging instruments. In addition, hedging using market models leads to similar performance to hedging using Heston models, while the former tends to be more robust during stressed market periods.

Keywords: Market models, European options, market simulators, no-arbitrage, neural-SDE, hedging

Suggested Citation

Cohen, Samuel N. and Reisinger, Christoph and Reisinger, Christoph and Wang, Sheng, Hedging Option Books Using Neural-SDE Market Models (May 31, 2022). Available at SSRN: https://ssrn.com/abstract=4124541 or http://dx.doi.org/10.2139/ssrn.4124541

Samuel N. Cohen

University of Oxford - Mathematical Institute ( email )

Woodstock Road
Oxford, Oxfordshire OX26GG
United Kingdom

The Alan Turing Institute ( email )

British Library
96 Euston Road
London, NW1 2DB
United Kingdom

Christoph Reisinger

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

University of Oxford - Mathematical Institute ( email )

Radcliffe Observatory, Andrew Wiles Building
Woodstock Rd
Oxford, Oxfordshire OX2 6GG
United Kingdom

Sheng Wang (Contact Author)

University of Oxford - Mathematical Institute ( email )

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