Research articles for the 2020-03-15

A class of recursive optimal stopping problems with applications to stock trading
Katia Colaneri,Tiziano De Angelis

In this paper we introduce and solve a class of optimal stopping problems of recursive type. In particular, the stopping payoff depends directly on the value function of the problem itself. In a multi-dimensional Markovian setting we show that the problem is well posed, in the sense that the value is indeed the unique solution to a fixed point problem in a suitable space of continuous functions, and an optimal stopping time exists. The set-up and methodology are sufficiently general to allow the analysis of problems with both finite-time and infinite-time horizon. Finally we apply our class of problems to a model for stock trading in two different market venues and we determine the optimal stopping rule in that case.

Application of Deep Q-Network in Portfolio Management
Ziming Gao,Yuan Gao,Yi Hu,Zhengyong Jiang,Jionglong Su

Machine Learning algorithms and Neural Networks are widely applied to many different areas such as stock market prediction, face recognition and population analysis. This paper will introduce a strategy based on the classic Deep Reinforcement Learning algorithm, Deep Q-Network, for portfolio management in stock market. It is a type of deep neural network which is optimized by Q Learning. To make the DQN adapt to financial market, we first discretize the action space which is defined as the weight of portfolio in different assets so that portfolio management becomes a problem that Deep Q-Network can solve. Next, we combine the Convolutional Neural Network and dueling Q-net to enhance the recognition ability of the algorithm. Experimentally, we chose five lowrelevant American stocks to test the model. The result demonstrates that the DQN based strategy outperforms the ten other traditional strategies. The profit of DQN algorithm is 30% more than the profit of other strategies. Moreover, the Sharpe ratio associated with Max Drawdown demonstrates that the risk of policy made with DQN is the lowest.

Asymptotic expansion for the transition densities of stochastic differential equations driven by the gamma processes
Fan Jiang,Xin Zang,Jingping Yang

In this paper, enlightened by the asymptotic expansion methodology developed by Li(2013b) and Li and Chen (2016), we propose a Taylor-type approximation for the transition densities of the stochastic differential equations (SDEs) driven by the gamma processes, a special type of Levy processes. After representing the transition density as a conditional expectation of Dirac delta function acting on the solution of the related SDE, the key technical method for calculating the expectation of multiple stochastic integrals conditional on the gamma process is presented. To numerically test the efficiency of our method, we examine the pure jump Ornstein--Uhlenbeck (OU) model and its extensions to two jump-diffusion models. For each model, the maximum relative error between our approximated transition density and the benchmark density obtained by the inverse Fourier transform of the characteristic function is sufficiently small, which shows the efficiency of our approximated method.

Coronavirus and oil price crash: A note
Claudiu Albulescu

Coronavirus (COVID-19) creates fear and uncertainty, hitting the global economy and amplifying the financial markets volatility. The oil price reaction to COVID-19 was gradually accommodated until March 09, 2020, when, 49 days after the release of the first coronavirus monitoring report by the World Health Organization (WHO), Saudi Arabia floods the market with oil. As a result, international prices drop with more than 20% in one single day. Against this background, the purpose of this paper is to investigate the impact of COVID-19 numbers on crude oil prices, while controlling for the impact of financial volatility and the United States (US) economic policy uncertainty. Our ARDL estimation shows that the COVID-19 daily reported cases of new infections have a marginal negative impact on the crude oil prices in the long run. Nevertheless, by amplifying the financial markets volatility, COVID-19 also has an indirect effect on the recent dynamics of crude oil prices.

Disturbing the Peace: Anatomy of the Hostile Takeover of China Vanke Co
Taurai Muvunza,Terrill Franzt

Wang Shi, a business mogul who created his empire of wealth from scratch, relished in his fame and basked in the glory of his affluent business. Nothing lasts forever! After mastering the turbulent business of real estate development in his country and therefore enjoying a rising and robust stock price, China Vanke Co. Ltd ("Vanke") founder and Chairman of the Board of Directors, Wang Shi was suddenly presented with a scathing notice from the Hong Kong Stock Exchange: rival Baoneng Group ("Baoneng") filed the regulatory documentation indicating that it had nicodemously acquired 5% of his company and was looking to buy more. Vanke case became brutal and sparked national controversy over corporate governance and the role of Chinese government in capital markets.

Machine Learning Portfolio Allocation
Michael Pinelis,David Ruppert

We find economically and statistically significant gains from using machine learning to dynamically allocate between the market index and the risk-free asset. We model the market price of risk as a function of lagged dividend yields and volatilities to determine the optimal weights in the portfolio: reward-risk market timing. This involves forecasting the direction of next month's excess return, which gives the reward, and constructing a dynamic volatility estimator that is optimized with a machine learning model, which gives the risk. Reward-risk timing with machine learning provides substantial improvements over the market index in investor utility, alphas, Sharpe ratios, and maximum drawdowns, after accounting for transaction costs, leverage constraints, and on a new out-of-sample set of returns. This paper provides a unifying framework for machine learning applied to both return- and volatility-timing.for machine learning applied to both return- and volatility-timing.

Optimal hedging of a perpetual American put with a single trade
Cheng Cai,Tiziano De Angelis,Jan Palczewski

It is well-known that using delta hedging to hedge financial options is not feasible in practice. Traders often rely on discrete-time hedging strategies based on fixed trading times or fixed trading prices (i.e., trades only occur if the underlying asset's price reaches some predetermined values). Motivated by this insight and with the aim of obtaining explicit solutions, we consider the seller of a perpetual American put option who can hedge her portfolio once until the underlying stock price leaves a certain range of values $(a,b)$. We determine optimal trading boundaries as functions of the initial stock holding, and an optimal hedging strategy for a bond/stock portfolio. Optimality here refers to the variance of the hedging error at the (random) time when the stock leaves the interval $(a,b)$. Our study leads to analytical expressions for both the optimal boundaries and the optimal stock holding, which can be evaluated numerically with no effort.

Optimal market making with persistent order flow
Paul Jusselin

We address the issue of market making on electronic markets when taking into account the self exciting property of market order flow. We consider a market with order flows driven by Hawkes processes where one market maker operates, aiming at optimizing its profit. We characterize an optimal control solving this problem by proving existence and uniqueness of a viscosity solution to the associated Hamilton Jacobi Bellman equation. Finally we propose a methodology to approximate the optimal strategy.

Realized volatility and parametric estimation of Heston SDEs
Robert Azencott,Peng Ren,Ilya Timofeyev

We present a detailed analysis of \emph{observable} moments based parameter estimators for the Heston SDEs jointly driving the rate of returns $R_t$ and the squared volatilities $V_t$. Since volatilities are not directly observable, our parameter estimators are constructed from empirical moments of realized volatilities $Y_t$, which are of course observable. Realized volatilities are computed over sliding windows of size $\varepsilon$, partitioned into $J(\varepsilon)$ intervals. We establish criteria for the joint selection of $J(\varepsilon)$ and of the sub-sampling frequency of return rates data.

We obtain explicit bounds for the $L^q$ speed of convergence of realized volatilities to true volatilities as $\varepsilon \to 0$. In turn, these bounds provide also $L^q$ speeds of convergence of our observable estimators for the parameters of the Heston volatility SDE.

Our theoretical analysis is supplemented by extensive numerical simulations of joint Heston SDEs to investigate the actual performances of our moments based parameter estimators. Our results provide practical guidelines for adequately fitting Heston SDEs parameters to observed stock prices series.