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Explainable neural network for pricing and universal static hedging of contingent claims

Lokeshwar, V and Bharadwaj, V and Jain, S (2022) Explainable neural network for pricing and universal static hedging of contingent claims. In: Applied Mathematics and Computation, 417 .

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Official URL: https://doi.org/10.1016/j.amc.2021.126775


We present here a regress-later based Monte Carlo approach that uses neural networks for pricing multi-asset discretely-monitored contingent claims. The choice of specific architecture of the neural networks used in the proposed algorithm provides for interpretability of the model, a feature that is often desirable in the financial context. Specifically, the interpretation leads us to demonstrate that any discretely monitored contingent claim �possibly high-dimensional and path-dependent� under Markovian and no-arbitrage assumptions, can be semi-statically hedged using a portfolio of short maturity options. We also show, for Bermudan style derivatives, how the method can be used to obtain an upper and lower bound to the true price, where the lower bound is obtained by following a sub-optimal policy, while the upper bound is found by exploiting the dual formulation. Unlike other duality based upper bounds where one typically has to resort to nested simulation for constructing super-martingales, the martingales in the current approach come at no extra cost, without the need for any sub-simulations. We demonstrate through numerical examples the simplicity and efficiency of the method for both pricing and semi-static hedging of path-dependent options. © 2021 Elsevier Inc.

Item Type: Journal Article
Publication: Applied Mathematics and Computation
Publisher: Elsevier Inc.
Additional Information: The copyright for this article belongs to Elsevier Inc.
Keywords: Costs; Financial markets; Numerical methods, American monte carlo; Contingent claims; High-dimensional; Interpretability; Monte Carlo approach; Neural-networks; Regress late; Static hedging; Universal static hedging; Upper Bound, Monte Carlo methods
Department/Centre: Division of Interdisciplinary Sciences > Management Studies
Date Deposited: 24 Dec 2021 06:03
Last Modified: 24 Dec 2021 06:03
URI: http://eprints.iisc.ac.in/id/eprint/70657

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