Pricing Multi-Asset Bermudan Commodity Options with Stochastic Volatility Using Neural Networks

Kentaro Hoshisashi and Yuji Yamada ()
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Kentaro Hoshisashi: Department of Computer Science, University College London, London WC1E 6BT, UK
Yuji Yamada: Faculty of Business Sciences, University of Tsukuba, Tokyo 112-0012, Japan

JRFM, 2023, vol. 16, issue 3, 1-23

Abstract: It has been recognized that volatility in commodity markets fluctuates significantly depending on the demand–supply relationship and geopolitical risk, and that risk and financial management using multivariate derivatives are becoming more important. This study illustrates an application of multi-layered neural networks for multi-dimensional Bermudan option pricing problems assuming a multi-asset stochastic volatility model in commodity markets. In addition, we aim to identify continuation value functions for these option pricing problems by implementing smooth activation functions in the neural networks and evaluating their accuracy compared with other activation functions or regression techniques. First, we express the underlying asset dynamics using the multi-asset stochastic volatility model with mean reversion properties in the commodity market and formulate the multivariate Bermudan commodity option pricing problem. Subsequently, we apply multi-layer perceptrons in the neural network to represent the continuation value functions of Bermudan commodity options, wherein the entire neural network is trained using the least-squares Monte Carlo simulation method. Finally, we perform numerical experiments and demonstrate that applications of neural networks for Bermudan options in a multi-dimensional commodity market achieve sufficient accuracy with regard to various aspects, including changing the exercise dates, the number of layers/neurons, and the dimension of the problem.

Keywords: Bermudan commodity options; multi-layer perceptron; multi-asset stochastic volatility model (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2023
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