APPLICATION OF THE KALMAN FILTER FOR ESTIMATING CONTINUOUS TIME TERM STRUCTURE MODELS: EVIDENCE FROM THE UK AND GERMANY

Rana Chatterjee

No 346, Computing in Economics and Finance 2004 from Society for Computational Economics

Abstract: In this paper a state-space representation for the single-factor Cox, Ingersoll and Ross (1985) model is employed to analyse the intertemporal dynamics of the term structure for UK Gilts and Euro-denominated German Treasury bonds. Closed form solutions for the prices of discount bonds are derived such that they are a function of the unobserved instantaneous spot rate and the model's parameters. Quasi-maximum likelihood estimates of the model parameters are obtained by using the Kalman filter algorithm to calculate the likelihood function. Empirical results show that a one-factor CIR model provides an adequate description of the dynamics of the UK term structure of interest rates for the period 1999-2003. But it is unable to provide such a good description of the German term structure owing to its inability to account for the market price of risk

Keywords: Kalman filtering; term structure (search for similar items in EconPapers)
JEL-codes: E43 C50 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ets
Date: Written 2004-08-11
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