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Moving average options: Machine learning and Gauss-Hermite quadrature for a double non-Markovian problem

Ludovic Goudenège, Andrea Molent and Antonino Zanette

European Journal of Operational Research, 2022, vol. 303, issue 2, 958-974

Abstract: Evaluating moving average options is a tough computational challenge for the energy and commodity market as the payoff of the option depends on the prices of a certain underlying observed on a moving window so, when a long window is considered, the pricing problem becomes high dimensional. We present an efficient method for pricing Bermudan style moving average options, based on Gaussian Process Regression and Gauss-Hermite quadrature, thus named GPR-GHQ. Specifically, the proposed algorithm proceeds backward in time and, at each time-step, the continuation value is computed only in a few points by using Gauss-Hermite quadrature, and then it is learned through Gaussian Process Regression. We test the proposed approach in the Black-Scholes model, where the GPR-GHQ method is made even more efficient by exploiting the positive homogeneity of the continuation value, which allows one to reduce the problem size. Positive homogeneity is also exploited to develop a binomial Markov chain, which is able to deal efficiently with medium-long windows. Secondly, we test GPR-GHQ in the Clewlow-Strickland model, the reference framework for modeling prices of energy commodities. Then, we investigate the performance of the proposed method in the Heston model, which is a very popular model among the non-Gaussian ones. Finally, we consider a challenging problem which involves double non-Markovian feature, that is the rough-Bergomi model. In this case, the pricing problem is even harder since the whole history of the volatility process impacts the future distribution of the process. The manuscript includes a numerical investigation, which displays that GPR-GHQ is very accurate in pricing and computing the Greeks with respect to the Longstaff-Schwartz method and it is able to handle options with a very long window, thus overcoming the problem of high dimensionality.

Keywords: (B) finance; Moving average options; Gaussian process regression; Gauss-Hermite quadrature; Binomial tree (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.ejor.2022.03.002

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