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Risk-Neutral Generative Networks

Author

Listed:
  • Zhonghao Xian
  • Xing Yan
  • Cheuk Hang Leung
  • Qi Wu

Abstract

We present a functional generative approach to extract risk-neutral densities from market prices of options. Specifically, we model the log-returns on the time-to-maturity continuum as a stochastic curve driven by standard normal. We then use neural nets to represent the term structures of the location, the scale, and the higher-order moments, and impose stringent conditions on the learning process to ensure the neural net-based curve representation is free of static arbitrage. This specification is structurally clear in that it separates the modeling of randomness from the modeling of the term structures of the parameters. It is data adaptive in that we use neural nets to represent the shape of the stochastic curve. It is also generative in that the functional form of the stochastic curve, although parameterized by neural nets, is an explicit and deterministic function of the standard normal. This explicitness allows for the efficient generation of samples to price options across strikes and maturities, without compromising data adaptability. We have validated the effectiveness of this approach by benchmarking it against a comprehensive set of baseline models. Experiments show that the extracted risk-neutral densities accommodate a diverse range of shapes. Its accuracy significantly outperforms the extensive set of baseline models--including three parametric models and nine stochastic process models--in terms of accuracy and stability. The success of this approach is attributed to its capacity to offer flexible term structures for risk-neutral skewness and kurtosis.

Suggested Citation

  • Zhonghao Xian & Xing Yan & Cheuk Hang Leung & Qi Wu, 2024. "Risk-Neutral Generative Networks," Papers 2405.17770, arXiv.org.
  • Handle: RePEc:arx:papers:2405.17770
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    References listed on IDEAS

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