A Quantum Field Theory Term Structure Model Applied to Hedging

• Main Authors: WARACHKA, Mitchell Craig, Belal, Baaquie, Srikant, M.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2010
• Subjects: Bond portfolio; hedging; field theory model; variance minimization; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/2695
• Institution: Singapore Management University

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.