PROJECTING THE FORWARD RATE FLOW ONTO A FINITE DIMENSIONAL MANIFOLD

Erhan Bayraktar, Li Chen () and H. Vincent Poor ()
Additional contact information
Li Chen: Lehman Brothers, Fixed Income Derivatives Research, 745 Seventh Avenue, New York, NY 10019, USA
H. Vincent Poor: Department of Electrical Engineering, Princeton University, Princeton, NJ 08544, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2006, vol. 09, issue 05, 777-785

Abstract: Given a Heath–Jarrow–Morton (HJM) interest rate model $\mathcal{M}$ and a parametrized family of finite dimensional forward rate curves $\mathcal{G}$, this paper provides a technique for projecting the infinite dimensional forward rate curve rt given by $\mathcal{M}$ onto the finite dimensional manifold $\mathcal{G}$. The Stratonovich dynamics of the projected finite dimensional forward curve are derived and it is shown that, under the regularity conditions, the given Stratonovich differential equation has a unique strong solution. Moreover, this projection leads to an efficient algorithm for implicit parametric estimation of the infinite dimensional HJM model. The feasibility of this method is demonstrated by applying the generalized method of moments.

Keywords: Interest rate models; consistency problems; calibration of HJM models; infinite dimensional stochastic differential equations (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (2)

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Working Paper: Projecting the Forward Rate Flow on a Finite Dimensional Manifold (2003)
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DOI: 10.1142/S0219024906003743

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