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Simulated Likelihood Estimation of Diffusions with an Application to Exchange Rate Dynamics in Incomplete Markets

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  • Michael W. Brandt
  • Pedro Santa-Clara
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    Abstract

    We present an econometric method for estimating the parameters of a diffusion model from discretely sampled data. The estimator is transparent, adaptive, and inherits the asymptotic properties of the generally unattainable maximum likelihood estimator. We use this method to estimate a new continuous-time model of the Joint dynamics of interest rates in two countries and the exchange rate between the two currencies. The model allows financial markets to be incomplete and specifies the degree of incompleteness as a stochastic process. Our empirical results offer several new insights into the dynamics of exchange rates.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0274.

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    Date of creation: Aug 2001
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    Publication status: published as Brandt, Michel W. and Pedro Santa-Clara. "Simulated Likelihood Estimation Of Diffusions With An Application To Exchange Rate Dynamics In Incomplete Markets," Journal of Financial Economics, 2002, v63(2,Feb), 161-210.
    Handle: RePEc:nbr:nberte:0274

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    Cited by:
    1. Pan, Jun, 2002. "The jump-risk premia implicit in options: evidence from an integrated time-series study," Journal of Financial Economics, Elsevier, vol. 63(1), pages 3-50, January.
    2. Brandt, Michael & Cochrane, John & Santa-Clara, Pedro, 2001. "International Risk Sharing is Better Than You Think (or Exchange Rates are Much Too Smooth!," University of California at Los Angeles, Anderson Graduate School of Management qt1jw137zd, Anderson Graduate School of Management, UCLA.
    3. Singleton, Kenneth J., 2001. "Estimation of affine asset pricing models using the empirical characteristic function," Journal of Econometrics, Elsevier, vol. 102(1), pages 111-141, May.

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