Nonlinear Kalman Filtering in Affine Term Structure Models

Peter Christoffersen, Christian Dorion (), Kris Jacobs () and Lot?fi Karoui ()
Additional contact information
Christian Dorion: HEC Montreal, Postal: 3000, chemin de la Côte-Sainte-Catherine, Montréal (Québec), Canada H3T 2A7
Kris Jacobs: University of Houston and Tilburg University, Postal: Houston, TX 77204-6021, United States
Lot?fi Karoui: Goldman, Sachs & Co., Postal: Canada

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: When the relationship between security prices and state variables in dynamic term structure models is nonlinear, existing studies usually linearize this relationship because nonlinear fi?ltering is computationally demanding. We conduct an extensive investigation of this linearization and analyze the potential of the unscented Kalman ?filter to properly capture nonlinearities. To illustrate the advantages of the unscented Kalman ?filter, we analyze the cross section of swap rates, which are relatively simple non-linear instruments, and cap prices, which are highly nonlinear in the states. An extensive Monte Carlo experiment demonstrates that the unscented Kalman fi?lter is much more accurate than its extended counterpart in fi?ltering the states and forecasting swap rates and caps. Our fi?ndings suggest that the unscented Kalman fi?lter may prove to be a good approach for a number of other problems in fi?xed income pricing with nonlinear relationships between the state vector and the observations, such as the estimation of term structure models using coupon bonds and the estimation of quadratic term structure models.

Keywords: Kalman filtering; nonlinearity; term structure models; swaps; caps. (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 48
Date: 2012-05-14
New Economics Papers: this item is included in nep-cmp, nep-ecm, nep-ets, nep-for and nep-ore
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Nonlinear Kalman Filtering in Affine Term Structure Models (2014)
Working Paper: Nonlinear Kalman Filtering in Affine Term Structure Models (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2012-49

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