Generative Bayesian neural network model for risk-neutral pricing of American index options

Financial models with stochastic volatility or jumps play a critical role as alternative option pricing models for the classical Black–Scholes model, which have the ability to fit different market volatility structures. Recently, machine learning models have elicited considerable attention from researchers because of their improved prediction accuracy in pricing financial derivatives. We propose a generative Bayesian learning model that incorporates a prior reflecting a risk-neutral pricing structure to provide fair prices for the deep ITM and the deep OTM options that are rarely traded. We conduct a comprehensive empirical study to compare classical financial option models with machine learning models in terms of model estimation and prediction using S&P 100 American put options from 2003 to 2012. Results indicate that machine learning models demonstrate better prediction performance than the classical financial option models. Especially, we observe that the generative Bayesian neural network model demonstrates the best overall prediction performance.