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Institute
Monte Carlo methods : barrier option pricing with stable Greeks and multilevel Monte Carlo learning
(2021)
For discretely observed barrier options, there exists no closed solution under the Black-Scholes model. Thus, it is often helpful to use Monte Carlo simulations, which are easily adapted to these models. However, as presented above, the discontinuous payoff may lead to instability in option's sensitivities for Monte Carlo algorithms.
This thesis presents a new Monte Carlo algorithm that can calculate the pathwise sensitivities for discretely monitored barrier options. The idea is based on Glasserman and Staum's one-step survival strategy and the results of Alm et al., with which we can stably determine the option's sensitivities such as Delta and Vega by finite-differences. The basic idea of Glasserman and Staum is to use a truncated normal distribution, which excludes the values above the barrier (e.g.\ for knock-up-out options), instead of sampling from the full normal distribution. This approach avoids the discontinuity generated by any Monte Carlo path crossing the barrier and yields a Lipschitz-continuous payoff function.
The new part will be to develop an extended algorithm that estimates the sensitivities directly, without simulation at multiple parameter values as in finite-difference.
Consider the local volatility model, which is a generalisation of the Black-Scholes model. Although standard Monte Carlo algorithms work well for the pricing of continuously monitored barrier options within this model, they often do not behave stably with respect to numerical differentiation.
To bypass this problem, one would generally either resort to regularised differentiation schemes or derive an algorithm for precise differentiation. Unfortunately, while the widespread solution of using a Brownian bridge approach leads to accurate first derivatives, they are not Lipschitz-continuous. This leads to instability with respect to numerical differentiation for second-order Greeks.
To alleviate this problem - i.e. produce Lipschitz-continuous first-order derivatives - and reduce variance, we generalise the idea of one-step survival to general scalar stochastic differential equations. This approach leads to the new one-step survival Brownian bridge approximation, which allows for stable second-order Greeks calculations.
To show the new approach's numerical efficiency, we present a new respective Monte Carlo pathwise sensitivity estimator for the first-order Greeks and study different methods to compute second-order Greeks stably. Finally, we develop a one-step survival Brownian bridge multilevel Monte Carlo algorithm to reduce the computational cost in practice.
This thesis proves unbiasedness and variance reduction of our new, one-step survival version with respect to the classical, Brownian bridge approach. Furthermore, we will present a new convergence result for the Brownian bridge approach using the Milstein scheme under certain conditions. Overall, these properties imply convergence of the new one-step survival Brownian bridge approach.
In recent years, deep learning has become pervasive in various fields. As a family of machine learning methods it is used in a broad set of applications, such as image processing, voice recognition, email filtering, computer vision. Most modern deep learning algorithms are based on artificial neural networks inspired by the biological neural networks constituting animal brains. Also in computational finance deep learning may be of use: Consider there is no closed-solution available for an option price, Monte Carlo simulations are substantially for estimation. Instead of persistently contributing new price computations arising from an updated volatility term, one could replace these by evaluating a neural network.
If an according neural network is available, the evaluation could lead to substantial savings and be highly efficient. I.e., once trained, a neural network could save further expensive estimations. However, in practice, the challenge is the training process of the neural network.
We study and compare two generic neural network training algorithms' computational complexity. Then, we introduce a new multilevel training algorithm that combines a deep learning algorithm with the idea of multilevel Monte Carlo path simulation. The idea is to train several neural networks with training data computed from the so-called level estimators of the multilevel Monte Carlo approach introduced by Giles. We show that the new method can reduce computational complexity by formulating a complexity theorem.
This thesis concerns three specific constraint satisfaction problems: the k-SAT problem, random linear equations and the Potts model. We investigated a phenomenon called replica symmetry, its consequences and its limitation. For the $k$-SAT problem, we were able to show that replica symmetry holds up to a threshold $d^{*}$. However, after another critical threshold $d^{**}$, we discovered that replica symmetry could not hold anymore, which enabled us to establish the existence of a replica symmetry breaking region. For the random linear problem, a peculiar phenomenon occurs. We observed that a more robust version of replica symmetry (strong replica symmetry) holds up to a threshold $d=e$ and ceases to hold after. This phenomenon is linked to the fact that before the threshold $d=e$, the fraction of frozen variables, i.e. variable forced to take the same value in all solutions, is concentrated around a deterministic value but vacillates between two values with equal probability for $d>e$. Lastly, for the Potts model, we show that a phenomenon called metastability occurs. The latter phenomenon can be understood as a consequence of trivial replica symmetry breaking scheme. This metastability phenomenon further produces slow mixing results for two famous Markov chains, the Glauber and the Swendsen-Wang dynamics.
In the first part of this thesis, we introduce the concept of prospective strict no-arbitrage for discrete-time financial market models with proportional transaction. The prospective strict no-arbitrage condition, which is a variant of strict no-arbitrage, is slightly weaker than the robust no-arbitrage condition. It still implies that the set of portfolios attainable from zero initial endowment is closed in probability. Consequently, prospective strict no-arbitrage implies the existence of consistent prices, which may lie on the boundary of the bid-ask spread. A weak version of prospective strict no-arbitrage turns out to be equivalent to the existence of a consistent price system.
In continuous-time financial market models with proportional transaction costs, efficient friction, i.e., nonvanishing transaction costs, is a standing assumption. Together with robust no free lunch with vanishing risk, it rules out strategies of infinite variation which usually appear in frictionless financial markets. In the second part of this thesis, we show how models with and without transaction costs can be unified. The bid and the ask price of a risky asset are given by cadlag processes which are locally bounded from below and may coincide at some points. In a first step, we show that if the bid-ask model satisfies no unbounded profit with bounded risk for simple long-only strategies, then there exists a semimartingale lying between the bid and the ask price process.
In a second step, under the additional assumption that the zeros of the bid-ask spread are either starting points of an excursion away from zero or inner points from the right, we show that for every bounded predictable strategy specifying the amount of risky assets, the semimartingale can be used to construct the corresponding self-financing risk-free position in a consistent way. Finally, the set of most general strategies is introduced, which also provides a new view on the frictionless case.