Microinformation, Nonlinear Filtering, and Granularity

Patrick Gagliardini (), Christian Gourieroux and Alain Monfort

Journal of Financial Econometrics, 2010, vol. 10, issue 1, 1-53

Abstract: The recursive prediction and filtering formulas of the Kalman filter are difficult to implement in nonlinear state space models since they require the updating of a function. The aim of this paper is to consider the situation of a large number n of individual measurements, called microinformation, and to take advantage of the large cross-sectional size to get closed-form prediction and filtering formulas at order 1/n. The state variables have a macrofactor interpretation. The results are applied to maximum likelihood estimation of a macroparameter and to computation of a granularity adjusted Value-at-Risk (VaR) for large portfolios. The granularity adjustment for VaR is illustrated by an application of the value of the firm model (Merton, 1974, Journal of Finance 29, 449--470) taking into account both default and loss given default. Copyright The Author 2011. Published by Oxford University Press. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Date: 2010
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