Proper integration of market expectations into option hedging frameworks with transaction costs

Determine a rigorous and principled methodology to properly integrate market expectations into dynamic option hedging frameworks that manage local risk, incorporate standard options as hedging instruments, and explicitly account for proportional transaction costs, so that forward-looking information can systematically inform rebalancing and risk control decisions.

Background

In the Introduction, the authors review methodologies that manage local risk while including options as hedging instruments and accounting for transaction costs. They note that, despite these advances, how to integrate market expectations into such frameworks is not yet resolved.

The paper proposes a deep reinforcement learning approach that leverages the full implied volatility surface to inform hedging decisions. The highlighted open question underscores a gap in prior literature regarding the systematic incorporation of forward-looking market information into practical hedging strategies under realistic trading frictions.