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Reinforcement Learning and Deep Stochastic Optimal Control for Final Quadratic Hedging

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  • Bernhard Hientzsch

Abstract

We consider two data driven approaches, Reinforcement Learning (RL) and Deep Trajectory-based Stochastic Optimal Control (DTSOC) for hedging a European call option without and with transaction cost according to a quadratic hedging P&L objective at maturity ("variance-optimal hedging" or "final quadratic hedging"). We study the performance of the two approaches under various market environments (modeled via the Black-Scholes and/or the log-normal SABR model) to understand their advantages and limitations. Without transaction costs and in the Black-Scholes model, both approaches match the performance of the variance-optimal Delta hedge. In the log-normal SABR model without transaction costs, they match the performance of the variance-optimal Barlett's Delta hedge. Agents trained on Black-Scholes trajectories with matching initial volatility but used on SABR trajectories match the performance of Bartlett's Delta hedge in average cost, but show substantially wider variance. To apply RL approaches to these problems, P&L at maturity is written as sum of step-wise contributions and variants of RL algorithms are implemented and used that minimize expectation of second moments of such sums.

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  • Bernhard Hientzsch, 2023. "Reinforcement Learning and Deep Stochastic Optimal Control for Final Quadratic Hedging," Papers 2401.08600, arXiv.org.
    • Handle: RePEc:arx:papers:2401.08600
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    References listed on IDEAS

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    1. Jian Liang & Zhe Xu & Peter Li, 2021. "Deep learning-based least squares forward-backward stochastic differential equation solver for high-dimensional derivative pricing," Quantitative Finance, Taylor & Francis Journals, vol. 21(8), pages 1309-1323, August.
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    Cited by:

    1. Hardik Routray & Bernhard Hientzsch, 2024. "Enforcing asymptotic behavior with DNNs for approximation and regression in finance," Papers 2411.05257, arXiv.org.

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