Robust Risk-Aware Option Hedging

David Wu and Sebastian Jaimungal

Applied Mathematical Finance, 2023, vol. 30, issue 3, 153-174

Abstract: The objectives of option hedging/trading extend beyond mere protection against downside risks, with a desire to seek gains also driving agent's strategies. In this study, we showcase the potential of robust risk-aware reinforcement learning (RL) in mitigating the risks associated with path-dependent financial derivatives. We accomplish this by leveraging a policy gradient approach that optimizes robust risk-aware performance criteria. We specifically apply this methodology to the hedging of barrier options, and highlight how the optimal hedging strategy undergoes distortions as the agent moves from being risk-averse to risk-seeking. As well as how the agent robustifies their strategy. We further investigate the performance of the hedge when the data generating process (DGP) varies from the training DGP, and demonstrate that the robust strategies outperform the non-robust ones.

Date: 2023
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DOI: 10.1080/1350486X.2023.2301354

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