Comparison of Field Theory Models of Interest Rates with Market Data

We calibrate and test various variants of field theory models of the interest rate with data from eurodollars futures. A model based on a simple psychological factor are seen to provide the best fit to the market. We make a model independent determination of the volatility function of the forward rates from market data.Comment: 9 figure

A Path Integral Approach to Option Pricing with Stochastic Volatility: Some Exact Results

The Black-Scholes formula for pricing options on stocks and other securities has been generalized by Merton and Garman to the case when stock volatility is stochastic. The derivation of the price of a security derivative with stochastic volatility is reviewed starting from the first principles of finance. The equation of Merton and Garman is then recast using the path integration technique of theoretical physics. The price of the stock option is shown to be the analogue of the Schrodinger wavefuction of quantum mechacnics and the exact Hamiltonian and Lagrangian of the system is obtained. The results of Hull and White are generalized results for pricing stock options for the general correlated case are derived.Comment: Needs subeqnarray.sty. To appear in J. de Phys. I (Dec 97

A Common Market Measure for Libor and Pricing Caps, Floors and Swaps in a Field Theory of Forward Interest Rates

The main result of this paper that a martingale evolution can be chosen for Libor such that all the Libor interest rates have a common market measure; the drift is fixed such that each Libor has the martingale property. Libor is described using a field theory model, and a common measure is seen to be emerge naturally for such models. To elaborate how the martingale for the Libor belongs to the general class of numeraire for the forward interest rates, two other numeraire's are considered, namely the money market measure that makes the evolution of the zero coupon bonds a martingale, and the forward measure for which the forward bond price is a martingale. The price of an interest rate cap is computed for all three numeraires, and is shown to be numeraire invariant. Put-call parity is discussed in some detail and shown to emerge due to some non-trivial properties of the numeraires. Some properties of swaps, and their relation to caps and floors, are briefly discussed.Comment: 28 pages, 4 figure

Superstrings, Gauge Fields and Black Holes

There has been spectacular progress in the development of string and superstring theories since its inception thirty years ago. Development in this area has never been impeded by the lack of experimental confirmation. Indeed, numerous bold and imaginative strides have been taken and the sheer elegance and logical consistency of the arguments have served as a primary motivation for string theorists to push their formulations ahead. In fact the development in this area has been so rapid that new ideas quickly become obsolete. On the other hand, this rapid development has proved to be the greatest hindrance for novices interested in this area. These notes serve as a gentle introduction to this topic. In these elementary notes, we briefly review the RNS formulation of superstring theory, GSO projection, $D$-branes, bosonic strings, dualities, dynamics of $D$-branes and the microscopic description of Bekenstein entropy of a black hole.Comment: Lecture notes for talk delivered at NUS in 1997-1998. Some recent updates added. The material may be somewhat outdated but it could still be useful for physicists new to the fiel

Maximum temperature for an Ideal Gas of U^(1)\hat U(1) Kac-Moody Fermions

A lagrangian for gauge fields coupled to fermions with the Kac-Moody group as its gauge group yields, for the pure fermions sector, an ideal gas of Kac-Moody fermions. The canonical partition function for the $\hat U(1)$ case is shown to have a maximum temperature $kT_{M} = |\lambda| /\pi$, where $\lambda$ is the coupling of the super charge operator $G_0$ to the fermions. This result is similar to the case of strings but unlike strings the result is obtained from a well-defined lagrangian.Comment: Needs subeqnarray.sty; To be published in Phys. Rev. D, Dec 15, 1995. Some typographical errors have been corrected in the revised versio

Quantum Field Theory of Forward Rates with Stochastic Volatility

In a recent formulation of a quantum field theory of forward rates, the volatility of the forward rates was taken to be deterministic. The field theory of the forward rates is generalized to the case of stochastic volatility. Two cases are analyzed, firstly when volatility is taken to be a function of the forward rates, and secondly when volatility is taken to be an independent quantum field. Since volatiltiy is a positive valued quantum field, the full theory turns out to be an interacting nonlinear quantum field theory in two dimensions. The state space and Hamiltonian for the interacting theory are obtained, and shown to have a nontrivial structure due to the manifold moving with a constant velocity. The no arbitrage condition is reformulated in terms of the Hamiltonian of the system, and then exactly solved for the nonlinear interacting case.Comment: 7 Figure

Market dynamics immediately before and after financial shocks: quantifying the Omori, productivity and Bath laws

We study the cascading dynamics immediately before and immediately after 219 market shocks. We define the time of a market shock T_{c} to be the time for which the market volatility V(T_{c}) has a peak that exceeds a predetermined threshold. The cascade of high volatility "aftershocks" triggered by the "main shock" is quantitatively similar to earthquakes and solar flares, which have been described by three empirical laws --- the Omori law, the productivity law, and the Bath law. We analyze the most traded 531 stocks in U.S. markets during the two-year period 2001-2002 at the 1-minute time resolution. We find quantitative relations between (i) the "main shock" magnitude M \equiv \log V(T_{c}) occurring at the time T_{c} of each of the 219 "volatility quakes" analyzed, and (ii) the parameters quantifying the decay of volatility aftershocks as well as the volatility preshocks. We also find that stocks with larger trading activity react more strongly and more quickly to market shocks than stocks with smaller trading activity. Our findings characterize the typical volatility response conditional on M, both at the market and the individual stock scale. We argue that there is potential utility in these three statistical quantitative relations with applications in option pricing and volatility trading.Comment: 16 pages, double column, 13 figures, 1 Table; Changes made in Version 2 in response to referee comment

The Kinetic Interpretation of the DGLAP Equation, its Kramers-Moyal Expansion and Positivity of Helicity Distributions

According to a rederivation - due to Collins and Qiu - the DGLAP equation can be reinterpreted (in leading order) in a probabilistic way. This form of the equation has been used indirectly to prove the bound $|\Delta f(x,Q)| < f(x,Q)$ between polarized and unpolarized distributions, or positivity of the helicity distributions, for any $Q$. We reanalize this issue by performing a detailed numerical study of the positivity bounds of the helicity distributions. To obtain the numerical solution we implement an x-space based algorithm for polarized and unpolarized distributions to next-to-leading order in $\alpha_s$, which we illustrate. We also elaborate on some of the formal properties of the Collins-Qiu form and comment on the underlying regularization, introduce a Kramers-Moyal expansion of the equation and briefly analize its Fokker-Planck approximation. These follow quite naturally once the master version is given. We illustrate this expansion both for the valence quark distribution $q_V$ and for the transverse spin distribution $h_1$.Comment: 38 pages, 27 figures, Dedicated to Prof. Pierre Ramond for his 60th birthda

Generalized pricing formulas for stochastic volatility jump diffusion models applied to the exponential Vasicek model

Path integral techniques for the pricing of financial options are mostly based on models that can be recast in terms of a Fokker-Planck differential equation and that, consequently, neglect jumps and only describe drift and diffusion. We present a method to adapt formulas for both the path-integral propagators and the option prices themselves, so that jump processes are taken into account in conjunction with the usual drift and diffusion terms. In particular, we focus on stochastic volatility models, such as the exponential Vasicek model, and extend the pricing formulas and propagator of this model to incorporate jump diffusion with a given jump size distribution. This model is of importance to include non-Gaussian fluctuations beyond the Black-Scholes model, and moreover yields a lognormal distribution of the volatilities, in agreement with results from superstatistical analysis. The results obtained in the present formalism are checked with Monte Carlo simulations.Comment: 9 pages, 2 figures, 1 tabl

Brownian markets

Financial market dynamics is rigorously studied via the exact generalized Langevin equation. Assuming market Brownian self-similarity, the market return rate memory and autocorrelation functions are derived, which exhibit an oscillatory-decaying behavior with a long-time tail, similar to empirical observations. Individual stocks are also described via the generalized Langevin equation. They are classified by their relation to the market memory as heavy, neutral and light stocks, possessing different kinds of autocorrelation functions