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Hedging LIBOR derivatives in a field theory model of interest rates

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  • Baaquie, Belal E.
  • Liang, Cui
  • Warachka, Mitch C.

Abstract

We investigate LIBOR-based derivatives using a parsimonious field theory interest rate model capable of instilling imperfect correlation between different maturities. Delta and Gamma hedge parameters are derived for LIBOR caps against fluctuations in underlying forward rates. An empirical illustration of our methodology is conducted to demonstrate the influence of correlation on the hedging of interest rate risk.

Suggested Citation

  • Baaquie, Belal E. & Liang, Cui & Warachka, Mitch C., 2007. "Hedging LIBOR derivatives in a field theory model of interest rates," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 374(2), pages 730-748.
    • Handle: RePEc:eee:phsmap:v:374:y:2007:i:2:p:730-748
    DOI: 10.1016/j.physa.2006.08.020
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    References listed on IDEAS

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    1. Belal E. Baaquie, 2005. "A Common Market Measure For Libor And Pricing Caps, Floors And Swaps In A Field Theory Of Forward Interest Rates," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(08), pages 999-1018.
    2. Belal E. Baaquie & Marakani Srikant & Mitch C. Warachka, 2003. "A Quantum Field Theory Term Structure Model Applied to Hedging," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 6(05), pages 443-467.
    3. Jean-Philippe Bouchaud & Nicolas Sagna & Rama Cont & Nicole El-Karoui & Marc Potters, 1999. "Phenomenology of the interest rate curve," Applied Mathematical Finance, Taylor & Francis Journals, vol. 6(3), pages 209-232.
    4. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305, World Scientific Publishing Co. Pte. Ltd..
    5. Belal E. Baaquie, 2005. "A Common Market Measure for Libor and Pricing Caps, Floors and Swaps in a Field Theory of Forward Interest Rates," Papers physics/0503126, arXiv.org.
    6. Unknown, 2005. "Forward," 2005 Conference: Slovenia in the EU - Challenges for Agriculture, Food Science and Rural Affairs, November 10-11, 2005, Moravske Toplice, Slovenia 183804, Slovenian Association of Agricultural Economists (DAES).
    7. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    8. Andrew Matacz & Jean-Philippe Bouchaud, 2000. "An Empirical Investigation Of The Forward Interest Rate Term Structure," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 3(04), pages 703-729.
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