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Application of Tensor Neural Networks to Pricing Bermudan Swaptions

Author

Listed:
  • Raj G. Patel
  • Tomas Dominguez
  • Mohammad Dib
  • Samuel Palmer
  • Andrea Cadarso
  • Fernando De Lope Contreras
  • Abdelkader Ratnani
  • Francisco Gomez Casanova
  • Senaida Hern'andez-Santana
  • 'Alvaro D'iaz-Fern'andez
  • Eva Andr'es
  • Jorge Luis-Hita
  • Escol'astico S'anchez-Mart'inez
  • Samuel Mugel
  • Roman Orus

Abstract

The Cheyette model is a quasi-Gaussian volatility interest rate model widely used to price interest rate derivatives such as European and Bermudan Swaptions for which Monte Carlo simulation has become the industry standard. In low dimensions, these approaches provide accurate and robust prices for European Swaptions but, even in this computationally simple setting, they are known to underestimate the value of Bermudan Swaptions when using the state variables as regressors. This is mainly due to the use of a finite number of predetermined basis functions in the regression. Moreover, in high-dimensional settings, these approaches succumb to the Curse of Dimensionality. To address these issues, Deep-learning techniques have been used to solve the backward Stochastic Differential Equation associated with the value process for European and Bermudan Swaptions; however, these methods are constrained by training time and memory. To overcome these limitations, we propose leveraging Tensor Neural Networks as they can provide significant parameter savings while attaining the same accuracy as classical Dense Neural Networks. In this paper we rigorously benchmark the performance of Tensor Neural Networks and Dense Neural Networks for pricing European and Bermudan Swaptions, and we show that Tensor Neural Networks can be trained faster than Dense Neural Networks and provide more accurate and robust prices than their Dense counterparts.

Suggested Citation

  • Raj G. Patel & Tomas Dominguez & Mohammad Dib & Samuel Palmer & Andrea Cadarso & Fernando De Lope Contreras & Abdelkader Ratnani & Francisco Gomez Casanova & Senaida Hern'andez-Santana & 'Alvaro D'iaz, 2023. "Application of Tensor Neural Networks to Pricing Bermudan Swaptions," Papers 2304.09750, arXiv.org, revised Mar 2024.
  • Handle: RePEc:arx:papers:2304.09750
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    References listed on IDEAS

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    1. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," University of California at Los Angeles, Anderson Graduate School of Management qt43n1k4jb, Anderson Graduate School of Management, UCLA.
    2. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," The Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 113-147.
    3. Jianjun Chen & Yongming Li & Ariel Neufeld, 2023. "Quantum Monte Carlo algorithm for solving Black-Scholes PDEs for high-dimensional option pricing in finance and its complexity analysis," Papers 2301.09241, arXiv.org, revised Apr 2024.
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