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

Author

Listed:
  • 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.

Suggested Citation

  • Belal Baaquie & Jean-Philippe Bouchaud, 2004. ""Stiff" Field Theory of Interest Rates and Psychological Future Time," Science & Finance (CFM) working paper archive 500064, Science & Finance, Capital Fund Management.
  • Handle: RePEc:sfi:sfiwpa:500064
    as

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    References listed on IDEAS

    as
    1. Santa-Clara, Pedro & Sornette, Didier, 2001. "The Dynamics of the Forward Interest Rate Curve with Stochastic String Shocks," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 149-185.
    2. 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.
    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. repec:wsi:ijtafx:v:03:y:2000:i:04:n:s0219024900000838 is not listed on IDEAS
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    JEL classification:

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

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