Scandinavian Working Papers in Economics
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Department of Economics, Lund University Working Papers, Department of Economics, Lund University

No 2001:5:
A Neural Network Versus Black-Scholes: A Comparison of Pricing and Hedging Performances

Henrik Amilon ()

Abstract: The Black-Scholes formula is a well-known model for pricing and hedging derivative securities. It relies, however, on several highly questionable assumptions. This paper examines whether a neural network (MLP) can be used to find a call option pricing formula better corresponding to market prices and the properties of the underlying asset than the Black-Scholes formula. The neural network method is applied to the out-of-sample pricing and delta-hedging of daily Swedish stock index call options from 1997-1999. The relevance of a hedge-analysis is stressed further in this paper. As benchmarks, the Black-Scholes model with historical and implicit volatility estimates is used. Comparisons reveal that the neural network models outperform the benchmarks both in pricing and hedging performances. A moving block bootstrap procedure is used to test the statistical significance of the results. Although the neural networks are superiour, the results are sometimes insignificant at the 5% level.

Keywords: option pricing; hedging; bootstrap; statistical inference; (follow links to similar papers)

JEL-Codes: C51; C52; G13; (follow links to similar papers)

25 pages, March 30, 2001, Revised August 3, 2001

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This paper is published as:
Amilon, Henrik, (2003), 'A Neural Network Versus Black-Scholes: A Comparison of Pricing and Hedging Performances', Journal of Forecasting, Vol. 22, pages 317-335

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