Spanning Multi‐Asset Payoffs With ReLUs

ABSTRACT We propose a distributional formulation of the spanning problem of a multi‐asset payoff by vanilla basket options. This problem is shown to have a unique solution if and only if the payoff function is even and absolutely homogeneous, and we establish a Fourier‐based formula to calculate the solution. Financial payoffs are typically piecewise linear, resulting in a solution that may be derived explicitly, yet may also be hard to exploit numerically. One‐hidden‐layer feedforward neural networks instead provide a natural and efficient numerical alternative for discrete spanning. We test this approach for a selection of archetypal payoffs and obtain better hedging results with vanilla basket options compared to industry‐favored approaches based on single‐asset vanilla hedges.