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Sebastian Jaimungal

Publications and source records attributed to Sebastian Jaimungal.

At least 55 records · Page 3Linked to original sources

Deep Learning for Principal-Agent Mean Field Games

Here, we develop a deep learning algorithm for solving Principal-Agent (PA) mean field games with market-clearing conditions -- a class of problems that have thus far not been studied and one that poses difficulties for standard numerical methods. We use an actor-critic approach to optimization, where the agents form a Nash equilibria according to the principal's penalty function, and the principal evaluates the resulting equilibria. The inner problem's Nash equilibria is obtained using a variant of the deep backward stochastic differential equation (BSDE) method modified for McKean-Vlasov forward-backward SDEs that includes dependence on the distribution over both the forward and backward processes. The outer problem's loss is further approximated by a neural net by sampling over the space of penalty functions. We apply our approach to a stylized PA problem arising in Renewable Energy Certificate (REC) markets, where agents may rent clean energy production capacity, trade RECs, and expand their long-term capacity to navigate the market at maximum profit. Our numerical results illustrate the efficacy of the algorithm and lead to interesting insights into the nature of optimal PA interactions in the mean-field limit of these markets.

cs.LG↗

A Mean-Field Game Approach to Equilibrium Pricing in Solar Renewable Energy Certificate Markets

Solar Renewable Energy Certificate (SREC) markets are a market-based system that incentivizes solar energy generation. A regulatory body imposes a lower bound on the amount of energy each regulated firm must generate via solar means, providing them with a tradeable certificate for each MWh generated. Firms seek to navigate the market optimally by modulating their SREC generation and trading rates. As such, the SREC market can be viewed as a stochastic game, where agents interact through the SREC price. We study this stochastic game by solving the mean-field game (MFG) limit with sub-populations of heterogeneous agents. Market participants optimize costs accounting for trading frictions, cost of generation, non-linear non-compliance costs, and generation uncertainty. Moreover, we endogenize SREC price through market clearing. We characterize firms' optimal controls as the solution of McKean-Vlasov (MV) FBSDEs and determine the equilibrium SREC price. We establish the existence and uniqueness of a solution to this MV-FBSDE, and prove that the MFG strategies form an $ε$-Nash equilibrium for the finite player game. Finally, we develop a numerical scheme for solving the MV-FBSDEs and conduct a simulation study.

q-fin.MF↗

Lévy-Ito Models in Finance

We present an overview of the broad class of financial models in which the prices of assets are Lévy-Ito processes driven by an $n$-dimensional Brownian motion and an independent Poisson random measure. The Poisson random measure is associated with an $n$-dimensional Lévy process. Each model consists of a pricing kernel, a money market account, and one or more risky assets. We show how the excess rate of return above the interest rate can be calculated for risky assets in such models, thus showing the relationship between risk and return when asset prices have jumps. The framework is applied to a variety of asset classes, allowing one to construct new models as well as interesting generalizations of familiar models.

q-fin.MF↗

Convex Analysis for LQG Systems with Applications to Major Minor LQG Mean-Field Game Systems

We develop a convex analysis approach for solving LQG optimal control problems and apply it to major-minor (MM) LQG mean-field game (MFG) systems. The approach retrieves the best response strategies for the major agent and all minor agents that attain an $ε$-Nash equilibrium. An important and distinctive advantage to this approach is that unlike the classical approach in the literature, we are able to avoid imposing assumptions on the evolution of the mean-field. In particular, this provides a tool for dealing with complex and non-standard systems.

eess.SY↗

Double Deep Q-Learning for Optimal Execution

Optimal trade execution is an important problem faced by essentially all traders. Much research into optimal execution uses stringent model assumptions and applies continuous time stochastic control to solve them. Here, we instead take a model free approach and develop a variation of Deep Q-Learning to estimate the optimal actions of a trader. The model is a fully connected Neural Network trained using Experience Replay and Double DQN with input features given by the current state of the limit order book, other trading signals, and available execution actions, while the output is the Q-value function estimating the future rewards under an arbitrary action. We apply our model to nine different stocks and find that it outperforms the standard benchmark approach on most stocks using the measures of (i) mean and median out-performance, (ii) probability of out-performance, and (iii) gain-loss ratios.

q-fin.TR↗

Mixing LSMC and PDE Methods to Price Bermudan Options

We develop a mixed least squares Monte Carlo-partial differential equation (LSMC-PDE) method for pricing Bermudan style options on assets whose volatility is stochastic. The algorithm is formulated for an arbitrary number of assets and volatility processes and we prove the algorithm converges almost surely for a class of models. We also discuss two methods to improve the algorithm's computational complexity. Our numerical examples focus on the single ($2d$) and multi-dimensional ($4d$) Heston models and we compare our hybrid algorithm with classical LSMC approaches. In each case, we find that the hybrid algorithm outperforms standard LSMC in terms of estimating prices and optimal exercise boundaries.

q-fin.CP↗

Trading Foreign Exchange Triplets

We develop the optimal trading strategy for a foreign exchange (FX) broker who must liquidate a large position in an illiquid currency pair. To maximize revenues, the broker considers trading in a currency triplet which consists of the illiquid pair and two other liquid currency pairs. The liquid pairs in the triplet are chosen so that one of the pairs is redundant. The broker is risk-neutral and accounts for model ambiguity in the FX rates to make her strategy robust to model misspecification. When the broker is ambiguity neutral (averse) the trading strategy in each pair is independent (dependent) of the inventory in the other two pairs in the triplet. We employ simulations to illustrate how the robust strategies perform. For a range of ambiguity aversion parameters, we find the mean Profit and Loss (P&L) of the strategy increases and the standard deviation of the P&L decreases as ambiguity aversion increases.

q-fin.TR↗

Optimal Behaviour in Solar Renewable Energy Certificate (SREC) Markets

SREC markets are a relatively novel market-based system to incentivize the production of energy from solar means. A regulator imposes a floor on the amount of energy each regulated firm must generate from solar power in a given period and provides them with certificates for each generated MWh. Firms offset these certificates against the floor and pay a penalty for any lacking certificates. Certificates are tradable assets, allowing firms to purchase/sell them freely. In this work, we formulate a stochastic control problem for generating and trading in SREC markets from a regulated firm's perspective. We account for generation and trading costs, the impact both have on SREC prices, provide a characterization of the optimal strategy, and develop a numerical algorithm to solve this control problem. Through numerical experiments, we explore how a firm who acts optimally behaves under various conditions. We find that an optimal firm's generation and trading behaviour can be separated into various regimes, based on the marginal benefit of obtaining an additional SREC, and validate our theoretical characterization of the optimal strategy. We also conduct parameter sensitivity experiments and conduct comparisons of the optimal strategy to other candidate strategies.

q-fin.MF↗

A Variational Analysis Approach to Solving the Merton Problem

We address the Merton problem of maximizing the expected utility of terminal wealth using techniques from variational analysis. Under a general continuous semimartingale market model with stochastic parameters, we obtain a characterization of the optimal portfolio for general utility functions in terms of a forward-backward stochastic differential equation (FBSDE) and derive solutions for a number of well-known utility functions. Our results complement a previous studies conducted on optimal strategies in markets driven by Brownian noise with random drift and volatility parameters.

q-fin.PM↗

Hedging Non-Tradable Risks with Transaction Costs and Price Impact

A risk-averse agent hedges her exposure to a non-tradable risk factor $U$ using a correlated traded asset $S$ and accounts for the impact of her trades on both factors. The effect of the agent's trades on $U$ is referred to as cross-impact. By solving the agent's stochastic control problem, we obtain a closed-form expression for the optimal strategy when the agent holds a linear position in $U$. When the exposure to the non-tradable risk factor $ψ(U_T)$ is non-linear, we provide an approximation to the optimal strategy in closed-form, and prove that the value function is correctly approximated by this strategy when cross-impact and risk-aversion are small. We further prove that when $ψ(U_T)$ is non-linear, the approximate optimal strategy can be written in terms of the optimal strategy for a linear exposure with the size of the position changing dynamically according to the exposure's "Delta" under a particular probability measure.

q-fin.MF↗

Mean-Field Games with Differing Beliefs for Algorithmic Trading

Even when confronted with the same data, agents often disagree on a model of the real-world. Here, we address the question of how interacting heterogenous agents, who disagree on what model the real-world follows, optimize their trading actions. The market has latent factors that drive prices, and agents account for the permanent impact they have on prices. This leads to a large stochastic game, where each agents' performance criteria are computed under a different probability measure. We analyse the mean-field game (MFG) limit of the stochastic game and show that the Nash equilibrium is given by the solution to a non-standard vector-valued forward-backward stochastic differential equation. Under some mild assumptions, we construct the solution in terms of expectations of the filtered states. Furthermore, we prove the MFG strategy forms an $ε$-Nash equilibrium for the finite player game. Lastly, we present a least-squares Monte Carlo based algorithm for computing the equilibria and show through simulations that increasing disagreement may increase price volatility and trading activity.

q-fin.MF↗

Latency and Liquidity Risk

Latency (i.e., time delay) in electronic markets affects the efficacy of liquidity taking strategies. During the time liquidity takers process information and send marketable limit orders (MLOs) to the exchange, the limit order book (LOB) might undergo updates, so there is no guarantee that MLOs are filled. We develop a latency-optimal trading strategy that improves the marksmanship of liquidity takers. The interaction between the LOB and MLOs is modelled as a marked point process. Each MLO specifies a price limit so the order can receive worse prices and quantities than those the liquidity taker targets if the updates in the LOB are against the interest of the trader. In our model, the liquidity taker balances the tradeoff between missing trades and the costs of walking the book. We employ techniques of variational analysis to obtain the optimal price limit of each MLO the agent sends. The price limit of a MLO is characterized as the solution to a new class of forward-backward stochastic differential equations (FBSDEs) driven by random measures. We prove the existence and uniqueness of the solution to the FBSDE and numerically solve it to illustrate the performance of the latency-optimal strategies.

q-fin.TR↗

Mean Field Game Systems with Common Noise and Markovian Latent Processes

In many stochastic games stemming from financial models, the environment evolves with latent factors and there may be common noise across agents' states. Two classic examples are: (i) multi-agent trading on electronic exchanges, and (ii) systemic risk induced through inter-bank lending/borrowing. Moreover, agents' actions often affect the environment, and some agent's may be small while others large. Hence sub-population of agents may act as minor agents, while another class may act as major agents. To capture the essence of such problems, here, we introduce a general class of non-cooperative heterogeneous stochastic games with one major agent and a large population of minor agents where agents interact with an observed common process impacted by the mean field. A latent Markov chain and a latent Wiener process (common noise) modulate the common process, and agents cannot observe them. We use filtering techniques coupled with a convex analysis approach to (i) solve the mean field game limit of the problem, (ii) demonstrate that the best response strategies generate an $ε$-Nash equilibrium for finite populations, and (iii) obtain explicit characterisations of the best response strategies.

math.OC↗

Mean Field Games with Partial Information for Algorithmic Trading

Financial markets are often driven by latent factors which traders cannot observe. Here, we address an algorithmic trading problem with collections of heterogeneous agents who aim to perform optimal execution or statistical arbitrage, where all agents filter the latent states of the world, and their trading actions have permanent and temporary price impact. This leads to a large stochastic game with heterogeneous agents. We solve the stochastic game by investigating its mean-field game (MFG) limit, with sub-populations of heterogeneous agents, and, using a convex analysis approach, we show that the solution is characterized by a vector-valued forward-backward stochastic differential equation (FBSDE). We demonstrate that the FBSDE admits a unique solution, obtain it in closed-form, and characterize the optimal behaviour of the agents in the MFG equilibrium. Moreover, we prove the MFG equilibrium provides an $ε$-Nash equilibrium for the finite player game. We conclude by illustrating the behaviour of agents using the optimal MFG strategy through simulated examples.

q-fin.MF↗

Active and Passive Portfolio Management with Latent Factors

We address a portfolio selection problem that combines active (outperformance) and passive (tracking) objectives using techniques from convex analysis. We assume a general semimartingale market model where the assets' growth rate processes are driven by a latent factor. Using techniques from convex analysis we obtain a closed-form solution for the optimal portfolio and provide a theorem establishing its uniqueness. The motivation for incorporating latent factors is to achieve improved growth rate estimation, an otherwise notoriously difficult task. To this end, we focus on a model where growth rates are driven by an unobservable Markov chain. The solution in this case requires a filtering step to obtain posterior probabilities for the state of the Markov chain from asset price information, which are subsequently used to find the optimal allocation. We show the optimal strategy is the posterior average of the optimal strategies the investor would have held in each state assuming the Markov chain remains in that state. Finally, we implement a number of historical backtests to demonstrate the performance of the optimal portfolio.

q-fin.PM↗

Outperformance and Tracking: Dynamic Asset Allocation for Active and Passive Portfolio Management

Portfolio management problems are often divided into two types: active and passive, where the objective is to outperform and track a preselected benchmark, respectively. Here, we formulate and solve a dynamic asset allocation problem that combines these two objectives in a unified framework. We look to maximize the expected growth rate differential between the wealth of the investor's portfolio and that of a performance benchmark while penalizing risk-weighted deviations from a given tracking portfolio. Using stochastic control techniques, we provide explicit closed-form expressions for the optimal allocation and we show how the optimal strategy can be related to the growth optimal portfolio. The admissible benchmarks encompass the class of functionally generated portfolios (FGPs), which include the market portfolio, as the only requirement is that they depend only on the prevailing asset values. Finally, some numerical experiments are presented to illustrate the risk-reward profile of the optimal allocation.

q-fin.PM↗

Technical Uncertainty in Real Options with Learning

We introduce a new approach to incorporate uncertainty into the decision to invest in a commodity reserve. The investment is an irreversible one-off capital expenditure, after which the investor receives a stream of cashflow from extracting the commodity and selling it on the spot market. The investor is exposed to price uncertainty and uncertainty in the amount of available resources in the reserves (i.e. technical uncertainty). She does, however, learn about the reserve levels through time, which is a key determinant in the decision to invest. To model the reserve level uncertainty and how she learns about the estimates of the commodity in the reserve, we adopt a continuous-time Markov chain model to value the option to invest in the reserve and investigate the value that learning has prior to investment.

q-fin.MF↗

Trading Cointegrated Assets with Price Impact

Executing a basket of co-integrated assets is an important task facing investors. Here, we show how to do this accounting for the informational advantage gained from assets within and outside the basket, as well as for the permanent price impact of market orders (MOs) from all market participants, and the temporary impact that the agent's MOs have on prices. The execution problem is posed as an optimal stochastic control problem and we demonstrate that, under some mild conditions, the value function admits a closed-form solution, and prove a verification theorem. Furthermore, we use data of five stocks traded in the Nasdaq exchange to estimate the model parameters and use simulations to illustrate the performance of the strategy. As an example, the agent liquidates a portfolio consisting of shares in Intel Corporation (INTC) and Market Vectors Semiconductor ETF (SMH). We show that including the information provided by three additional assets, FARO Technologies (FARO), NetApp (NTAP) and Oracle Corporation (ORCL), considerably improves the strategy's performance; for the portfolio we execute, it outperforms the multi-asset version of Almgren-Chriss by approximately 4 to 4.5 basis points.

q-fin.TR↗