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Volume 7,     Number 4,     Winter 1999

 

FILTERING AND PARAMETER ESTIMATION FOR
A MEAN REVERTING INTEREST RATE MODEL
R. ELLIOTT, P. FISCHER AND E. PLATEN

Abstract. A hidden Markov model with mean reverting characteristics is considered as a model for financial time series, particularly interest rates. The optimal filter for the state of the hidden Markov chain is obtained. A number of auxiliary filters are obtained that enable the parameters of the model to be estimated using the EM algorithm. A simulation study demonstrates the feasibility of this approach.

 

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