Machine learning for pricing American options in high-dimensional Markovian and non-Markovian models

Abstract

In this paper we propose two efficient techniques which allow one to compute the price of American basket options. In particular, we consider a basket of assets that follow a multi-dimensional Black–Scholes dynamics. The proposed techniques, called GPR Tree (GRP-Tree) and GPR Exact Integration (GPR-EI), are both based on Machine Learning, exploited together with binomial trees or with a closed form formula for integration. Moreover, these two methods solve the backward dynamic programing problem considering a Bermudan approximation of the American option. On the exercise dates, the value of the option is first computed as the maximum between the exercise value and the continuation value and then approximated by means of Gaussian Process Regression. The two methods mainly differ in the approach used to compute the continuation value: a single step of the binomial tree or integration according to the probability density of the process. Numerical results show that these two methods are accurate and reliable in handling American options on very large baskets of assets. Moreover we also consider the rough Bergomi model, which provides stochastic volatility with memory. Despite that this model is only bidimensional, the whole history of the process impacts on the price, and how to handle all this information is not obvious at all. To this aim, we present how to adapt the GPR-Tree and GPR-EI methods and we focus on pricing American options in this non-Markovian framework.

Keywords:

• Machine learning
• American options
• Multi-dimensional Black–Scholes model
• Rough Bergomi model
• Binomial tree method
• Exact integration

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

This work was supported by a public grant as part of the Investissement d'Avenir Project (PIA), reference ANR-11-LABX-0056-LMH, LabEx LMH. This LabEx Mathématiques Hadamard (LMH) is part of the laboratories of excellence (LABX) in mathematics operated by the French National Research Agency (ANR).