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"Stiff" Field Theory of Interest Rates and Psychological Future Time

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Author Info
Belal Baaquie (National University of Singapore, Department of Physics)
Jean-Philippe Bouchaud (Science & Finance, Capital Fund Management, CEA Saclay;)
Abstract

The simplest field theory description of the multivariate statistics of forward rate variations over time and maturities, involves a quadratic action containing a gradient squared rigidity term. However, this choice leads to a spurious kink (infinite curvature) of the normalized correlation function for coinciding maturities. Motivated by empirical results, we consider an extended action that contains a squared Laplacian term, which describes the bending stiffness of the FRC. With the extra ingredient of a `psychological' future time, describing how the perceived time between events depends on the time in the future, our theory accounts extremely well for the phenomenology of interest rate dynamics.

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Paper provided by Science & Finance, Capital Fund Management in its series Science & Finance (CFM) working paper archive with number 500064.

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Date of creation: Mar 2004
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Handle: RePEc:sfi:sfiwpa:500064

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G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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  1. Jean-Philippe Bouchaud & Nicolas Sagna & Rama Cont & Nicole El-Karoui & Marc Potters, 1997. "Phenomenology of the interest rate curve," Science & Finance (CFM) working paper archive 500048, Science & Finance, Capital Fund Management. [Downloadable!]
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  2. Heath, David & Jarrow, Robert & Morton, Andrew, 1992. "Bond Pricing and the Term Structure of Interest Rates: A New Methodology for Contingent Claims Valuation," Econometrica, Econometric Society, vol. 60(1), pages 77-105, January. [Downloadable!] (restricted)
  3. Santa-Clara, Pedro & Sornette, Didier, 2001. "The Dynamics of the Forward Interest Rate Curve with Stochastic String Shocks," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 14(1), pages 149-85.
  4. Andrew Matacz & Jean-Philippe Bouchaud, 1999. "An empirical investigation of the forward interest rate term structure," Science & Finance (CFM) working paper archive 500047, Science & Finance, Capital Fund Management. [Downloadable!]
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