Path Integral and Asset Pricing
Quantitative Finance 15(11) (2015) 1759-1771, Featured Article
30 Pages Posted: 7 Oct 2014 Last revised: 11 Aug 2016
Date Written: February 20, 2015
We give a pragmatic/pedagogical discussion of using Euclidean path integral in asset pricing. We then illustrate the path integral approach on short-rate models. By understanding the change of path integral measure in the Vasicek/Hull-White model, we can apply the same techniques to "less-tractable" models such as the Black-Karasinski model. We give explicit formulas for computing the bond pricing function in such models in the analog of quantum mechanical "semiclassical" approximation. We also outline how to apply perturbative quantum mechanical techniques beyond the "semiclassical" approximation, which are facilitated by Feynman diagrams.
Keywords: Path integral, asset pricing, short-rate models, Vasicek model, Hull-White model, Black-Karasinski model, pricing function, stochastic differential equation, quantum mechanics, perturbation theory, Feynman diagrams
JEL Classification: G00
Suggested Citation: Suggested Citation