A Quantum Field Theory Term Structure Model Applied to Hedging

Belal E. Baaquie (), Marakani Srikant and Mitch C. Warachka
Additional contact information
Belal E. Baaquie: Department of Physics, National University of Singapore, Kent Ridge, Singapore 117542, Singapore
Marakani Srikant: Department of Physics, National University of Singapore, Kent Ridge, Singapore 117542, Singapore
Mitch C. Warachka: School of Business, Singapore Management University, 469 Bukti Timah Road, Singapore 259756, Singapore

International Journal of Theoretical and Applied Finance (IJTAF), 2003, vol. 06, issue 05, 443-467

Abstract: A quantum field theory generalization, Baaquie [1], of the Heath, Jarrow and Morton (HJM) [10] term structure model parsimoniously describes the evolution of imperfectly correlated forward rates. Field theory also offers powerful computational tools to compute path integrals which naturally arise from all forward rate models. Specifically, incorporating field theory into the term structure facilitates hedge parameters that reduce to their finite factor HJM counterparts under special correlation structures. Although investors are unable to perfectly hedge against an infinite number of term structure perturbations in a field theory model, empirical evidence using market data reveals the effectiveness of a low dimensional hedge portfolio.

Keywords: Bond portfolio; hedging; field theory model; variance minimization (search for similar items in EconPapers)
Date: 2003
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Citations: View citations in EconPapers (3)

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DOI: 10.1142/S0219024903001980

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