Investigation of interest rate derivatives by quantum finance

Abstract

Interest rate derivatives are the largest derivatives market in the world. In or-der to price different interest rate derivatives, one needs to model the underlyingforward interest rate. Quantum finance developed by Baaquie is a framework tomodel non-trivial correlations between forward interest rates with different matu-rities as a parsimonious alternative to the existing interest rate theories in finance,in particular to the HJM-model. Base on the Quantum Finance framework, weempirically studied the Cap and Floor pricing, unlike Black's formula, the Quan-tum Finance formula generates the market price to an accuracy better than 90%.Also for swaption, the perturbation expansion formula generates the prices to anaccuracy of about 95% and matches all the trends of the market. We also givea efficient algorithm for pricing American option on interest rate based on latticefield theory model.