Option valuation under no-arbitrage constraints with neural networksTools Cao, Yi, Liu, Xiaoquan and Zhai, Jia (2021) Option valuation under no-arbitrage constraints with neural networks. European Journal of Operational Research, 293 (1). pp. 361-374. ISSN 03772217
Official URL: http://dx.doi.org/10.1016/j.ejor.2020.12.003
AbstractIn this paper, we start from the no-arbitrage constraints in option pricing and develop a novel hybrid gated neural network (hGNN) based option valuation model. We adopt a multiplicative structure of hidden layers to ensure model differentiability. We also select the slope and weights of input layers to satisfy the no-arbitrage constraints. Meanwhile, a separate neural network is constructed for predicting option-implied volatilities. Using S&P 500 options, our empirical analyses show that the hGNN model substantially outperforms well-established alternative mod els in the out-of-sample forecasting and hedging exercises. The superior prediction performance stems from our model’s ability in describing options on the boundary, and in offering analytical expressions for option Greeks which generate better hedging results.
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