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Chaotic Hedging with Iterated Integrals and Neural Networks

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  • Ariel Neufeld
  • Philipp Schmocker

Abstract

In this paper, we extend the Wiener-Ito chaos decomposition to the class of continuous semimartingales that are exponentially integrable, which includes in particular affine and some polynomial diffusion processes. By omitting the orthogonality in the expansion, we are able to show that every $p$-integrable functional of the semimartingale, for $p \in [1,\infty)$, can be represented as a sum of iterated integrals thereof. Using finitely many terms of this expansion and (possibly random) neural networks for the integrands, whose parameters are learned in a machine learning setting, we show that every financial derivative can be approximated arbitrarily well in the $L^p$-sense. In particular, for $p = 2$, we recover the optimal hedging strategy in the sense of quadratic hedging. Moreover, since the hedging strategy of the approximating option can be computed in closed form, we obtain an efficient algorithm to approximately replicate any sufficiently integrable financial derivative within short runtime.

Suggested Citation

  • Ariel Neufeld & Philipp Schmocker, 2022. "Chaotic Hedging with Iterated Integrals and Neural Networks," Papers 2209.10166, arXiv.org, revised Jul 2024.
  • Handle: RePEc:arx:papers:2209.10166
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    References listed on IDEAS

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    Cited by:

    1. Luca Galimberti & Anastasis Kratsios & Giulia Livieri, 2022. "Designing Universal Causal Deep Learning Models: The Case of Infinite-Dimensional Dynamical Systems from Stochastic Analysis," Papers 2210.13300, arXiv.org, revised May 2023.
    2. Christa Cuchiero & Philipp Schmocker & Josef Teichmann, 2023. "Global universal approximation of functional input maps on weighted spaces," Papers 2306.03303, arXiv.org, revised Feb 2024.
    3. Bruno Dupire & Valentin Tissot-Daguette, 2022. "Functional Expansions," Papers 2212.13628, arXiv.org, revised Mar 2023.

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