Simulation of nonlinear interest rates in quantum finance: Libor Market Model

Belal E. Baaquie and Pan Tang

Physica A: Statistical Mechanics and its Applications, 2012, vol. 391, issue 4, 1287-1308

Abstract: The simulation of the Libor Market Model (LMM) is extensively studied in the framework of quantum finance. The imperfectly correlated Libor rates are simulated based on a Gaussian quantum field and a recursion equation of nontrivial stochastic drift. The Libor options are studied using both the simulation method and the analytical formula. The caplet price of simulation is compared with Black’s caplet formula which can be exactly derived from the LMM. The invariance of caplet price for different forward bond numeraire is verified by using the simulation. The simulation results for coupon bond options and swaptions are compared with the approximate price, which are limited for the reason that the approximate price is derived using the small volatility expansion. The simulation method is shown to have great potential in the application of pricing interest rate instruments.

Keywords: Quantum finance; Libor Market Model; Coupon bond options; Caplet; Swaptions; Monte Carlo simulation (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:phsmap:v:391:y:2012:i:4:p:1287-1308

DOI: 10.1016/j.physa.2011.08.021

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