draft of paper appearing in %a stronglstrong. ingber.pdfVIP

Draft of paper appearing in: %A L. Ingber %T Statistical mechanical aids to calculating term structure models %J Phys. Rev. A %V 42 %D 1990 %P 7057-7064 Statistical mechanical aids to calculating term structure models Lester Ingber Science Transfer Corporation, P.O. Box 857, McLean, VA 22101 and Department of Mathematics, The George Washington University, Washington, DC 20052 Recent work in statistical mechanics has developed new analytical and numerical techniques to solve coupled stochastic equations. This paper describes application of the very fast simulated re- annealing and path-integral methodologies to the estimation of the Brennan and Schwartz two-factor term-structure (time-dependent) model of bond prices. It is shown that these methodologies can be utilized to estimate more complicated n-factor nonlinear models. Applications to other systems are stressed. Statistical mechanical aids - 2 - Lester Ingber 1. INTRODUCTION In this paper we present an alternative methodology of very fast simulated re-annealing (VFSR) [1] to compute the parameters of term-structure models, here applied to the evolution of interest rates. The term “term-structure” here is equivalent to “time-dependent,” wherein stochastic differential rate- equations are used to model these financial systems. It is also shown that the VFSR methodology is capable of handling complicated n-factor non-linear models. The advantages of using the simulated annealing methodo