Deep Hedging Bermudan Swaptions
Fuente:
arXiv
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| Format: | Preprint |
| Publié: |
2024
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| _version_ | 1866917839016820736 |
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| author | Oya, Kenjiro |
| author_facet | Oya, Kenjiro |
| contents | Abstract This paper proposes a novel approach to Bermudan swaption hedging by applying the deep hedging framework to address limitations of traditional arbitrage-free methods. Conventional methods assume ideal conditions, such as zero transaction costs, perfect liquidity, and continuous-time hedging, which often differ from real market environments. This discrepancy can lead to residual profit and loss (P&L), resulting in two primary issues. First, residual P&L may prevent achieving the initial model price, especially with improper parameter settings, potentially causing a negative P&L trend and significant financial impacts. Second, controlling the distribution of residual P&L to mitigate downside risk is challenging, as hedged positions may become curve gamma-short, making them vulnerable to large interest rate movements. The deep hedging approach enables flexible selection of convex risk measures and hedge strategies, allowing for improved residual P&L management. This study also addresses challenges in applying the deep hedging approach to Bermudan swaptions, such as efficient arbitrage-free market scenario generation and managing early exercise conditions. Additionally, we introduce a unique "Option Spread Hedge" strategy, which allows for robust hedging and provides intuitive interpretability. Numerical analysis results demonstrate the effectiveness of our approach. |
| format | Preprint |
| id |
arxiv_https___arxiv_org_abs_2411_10079 |
| institution | arXiv |
| publishDate | 2024 |
| record_format | arxiv |
| spellingShingle | Deep Hedging Bermudan Swaptions Oya, Kenjiro Computational Finance Pricing of Securities Abstract This paper proposes a novel approach to Bermudan swaption hedging by applying the deep hedging framework to address limitations of traditional arbitrage-free methods. Conventional methods assume ideal conditions, such as zero transaction costs, perfect liquidity, and continuous-time hedging, which often differ from real market environments. This discrepancy can lead to residual profit and loss (P&L), resulting in two primary issues. First, residual P&L may prevent achieving the initial model price, especially with improper parameter settings, potentially causing a negative P&L trend and significant financial impacts. Second, controlling the distribution of residual P&L to mitigate downside risk is challenging, as hedged positions may become curve gamma-short, making them vulnerable to large interest rate movements. The deep hedging approach enables flexible selection of convex risk measures and hedge strategies, allowing for improved residual P&L management. This study also addresses challenges in applying the deep hedging approach to Bermudan swaptions, such as efficient arbitrage-free market scenario generation and managing early exercise conditions. Additionally, we introduce a unique "Option Spread Hedge" strategy, which allows for robust hedging and provides intuitive interpretability. Numerical analysis results demonstrate the effectiveness of our approach. |
| title | Deep Hedging Bermudan Swaptions |
| topic | Computational Finance Pricing of Securities |
| url | https://arxiv.org/abs/2411.10079 |