Estimation in Models of the Instantaneous Short Term Interest Rate By Use of a Dynamic Bayesian Algorithm

Ram Bhar, Carl Chiarella and Wolfgang Runggaldier
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Ram Bhar: School of Banking and Finance, University of New South Wales

Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper considers the estimation in models of the instantaneous short interest rate from a new perspective. Rather than using discretely compounded market rates as a proxy for the instantaneous short rate of interest, we set up the stochastic dynamics for the discretely compounded market observed rates and propose a dynamic Bayesian estimation algorithm (i.e. a filtering algorithm) for a time-discretised version of the resulting interest rate dynamics. The filter solution is computed via a further spatial discretization (quantization) and the convergence of the latter to its continuous counterpart is discussed in detail. The method is applied to simulated data and is found to give a reasonable estimate of the conditional density function and to be not too demanding computationally.

Pages: 18 pages
Date: 2001-12-01
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Citations: View citations in EconPapers (4)

Published as: Bhar, R., Chiarella, C. and Runggaldier, W., 2002. "Estimation in Models of the Instantaneous Short Term Interest Rate By Use of a Dynamic Bayesian Algorithm", In: Advances in Finance and Stochastics, 177-195.

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