A pure dual approach for hedging Bermudan options

Aurélien Alfonsi (), Ahmed Kebaier () and Jérôme Lelong ()
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Aurélien Alfonsi: MATHRISK - Mathematical Risk Handling - UPEM - Université Paris-Est Marne-la-Vallée - ENPC - École nationale des ponts et chaussées - Centre Inria de Paris - Inria - Institut National de Recherche en Informatique et en Automatique, CERMICS - Centre d'Enseignement et de Recherche en Mathématiques et Calcul Scientifique - ENPC - École nationale des ponts et chaussées
Ahmed Kebaier: LaMME - Laboratoire de Mathématiques et Modélisation d'Evry - ENSIIE - Ecole Nationale Supérieure d'Informatique pour l'Industrie et l'Entreprise - UEVE - Université d'Évry-Val-d'Essonne - Université Paris-Saclay - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement
Jérôme Lelong: DAO - Données, Apprentissage et Optimisation - LJK - Laboratoire Jean Kuntzmann - Inria - Institut National de Recherche en Informatique et en Automatique - CNRS - Centre National de la Recherche Scientifique - UGA - Université Grenoble Alpes - Grenoble INP - Institut polytechnique de Grenoble - Grenoble Institute of Technology - UGA - Université Grenoble Alpes

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Abstract: This paper develops a new dual approach to compute the hedging portfolio of a Bermudan option and its initial value. It gives a "purely dual" algorithm following the spirit of Rogers (2010) in the sense that it only relies on the dual pricing formula. The key is to rewrite the dual formula as an excess reward representation and to combine it with a strict convexification technique. The hedging strategy is then obtained by using a Monte Carlo method, solving backward a sequence of least square problems. We show convergence results for our algorithm and test it on many different Bermudan options. Beyond giving directly the hedging portfolio, the strength of the algorithm is to assess both the relevance of including financial instruments in the hedging portfolio and the effect of the rebalancing frequency.

Keywords: Optimal stopping; Pure dual algorithm; Martingale; Least square Monte Carlo; Bermudan option; Hedging (search for similar items in EconPapers)
Date: 2024-04-29
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Published in Mathematical Finance, inPress, ⟨10.1111/mafi.12460⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04563713

DOI: 10.1111/mafi.12460

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