Jacky Chen

Parvin Malekzadeh, Zissis Poulos, Jacky Chen et al.

Recent advancements in Distributional Reinforcement Learning (DRL) for modeling loss distributions have shown promise in developing hedging strategies in derivatives markets. A common approach in DRL involves learning the quantiles of loss distributions at specified levels using Quantile Regression (QR). This method is particularly effective in option hedging due to its direct quantile-based risk assessment, such as Value at Risk (VaR) and Conditional Value at Risk (CVaR). However, these risk measures depend on the accurate estimation of extreme quantiles in the loss distribution's tail, which can be imprecise in QR-based DRL due to the rarity and extremity of tail data, as highlighted in the literature. To address this issue, we propose EXtreme DRL (EX-DRL), which enhances extreme quantile prediction by modeling the tail of the loss distribution with a Generalized Pareto Distribution (GPD). This method introduces supplementary data to mitigate the scarcity of extreme quantile observations, thereby improving estimation accuracy through QR. Comprehensive experiments on gamma hedging options demonstrate that EX-DRL improves existing QR-based models by providing more precise estimates of extreme quantiles, thereby improving the computation and reliability of risk metrics for complex financial risk management.

Rishal Aggarwal, Jacky Chen, Nicholas M. Boffi et al.

Efficient sampling from the Boltzmann distribution given its energy function is a key challenge for modeling complex physical systems such as molecules. Boltzmann Generators address this problem by leveraging continuous normalizing flows to transform a simple prior into a distribution that can be reweighted to match the target using sample likelihoods. Despite the elegance of this approach, obtaining these likelihoods requires computing costly Jacobians during integration, which is impractical for large molecular systems. To overcome this difficulty, we train an energy-based model (EBM) to approximate likelihoods using both noise contrastive estimation (NCE) and score matching, which we show outperforms the use of either objective in isolation. On 2d synthetic systems where failure can be easily visualized, NCE improves mode weighting relative to score matching alone. On alanine dipeptide, our method yields free energy profiles and energy distributions that closely match those obtained using exact likelihoods while achieving $100\times$ faster inference. By training on multiple dipeptide systems, we show that our approach also exhibits effective transfer learning, generalizing to new systems at inference time and achieving at least a $6\times$ speedup over standard MD. While many recent efforts in generative modeling have prioritized models with fast sampling, our work demonstrates the design of models with accelerated likelihoods, enabling the application of reweighting schemes that ensure unbiased Boltzmann statistics at scale. Our code is available at https://github.com/RishalAggarwal/BoltzNCE.

Jay Cao, Jacky Chen, John Hull et al.

This paper shows how reinforcement learning can be used to derive optimal hedging strategies for derivatives when there are transaction costs. The paper illustrates the approach by showing the difference between using delta hedging and optimal hedging for a short position in a call option when the objective is to minimize a function equal to the mean hedging cost plus a constant times the standard deviation of the hedging cost. Two situations are considered. In the first, the asset price follows a geometric Brownian motion. In the second, the asset price follows a stochastic volatility process. The paper extends the basic reinforcement learning approach in a number of ways. First, it uses two different Q-functions so that both the expected value of the cost and the expected value of the square of the cost are tracked for different state/action combinations. This approach increases the range of objective functions that can be used. Second, it uses a learning algorithm that allows for continuous state and action space. Third, it compares the accounting P&L approach (where the hedged position is valued at each step) and the cash flow approach (where cash inflows and outflows are used). We find that a hybrid approach involving the use of an accounting P&L approach that incorporates a relatively simple valuation model works well. The valuation model does not have to correspond to the process assumed for the underlying asset price.

Jay Cao, Jacky Chen, John Hull et al.

A common approach to valuing exotic options involves choosing a model and then determining its parameters to fit the volatility surface as closely as possible. We refer to this as the model calibration approach (MCA). A disadvantage of MCA is that some information in the volatility surface is lost during the calibration process and the prices of exotic options will not in general be consistent with those of plain vanilla options. We consider an alternative approach where the structure of the user's preferred model is preserved but points on the volatility are features input to a neural network. We refer to this as the volatility feature approach (VFA) model. We conduct experiments showing that VFA can be expected to outperform MCA for the volatility surfaces encountered in practice. Once the upfront computational time has been invested in developing the neural network, the valuation of exotic options using VFA is very fast.