Applying Linear Realization Theory to HJM Markovian Representation

Posted: 16 Sep 2009

See all articles by Xiaoxia Ye

Xiaoxia Ye

University of Liverpool Management School

Date Written: September 15, 2009

Abstract

Abstract This paper deals with constructing Finite Dimensional Realization (FDR) of HJM with time-invariant hump shape volatility by applying Linear Realization Theory. Two realization algorithms, Standard Observable Canonical Realization and Jordan Canonical Realization, are introduced. The equivalence between Jordan Canonical Realization algorithm and commonly adopted method of constructing FDR is shown by concrete example. At the same time, simulation results indicate that Standard Observable Canonical Realization is better choice for constructing FDR than Jordan Canonical Realization in terms of more precisely capturing the state variables.

Keywords: HJM, Finite Dimensional Realization, Markovian Representation, Hump shape volatility, Linear Realization Theory, State Space framework, Kalman Filter

JEL Classification: G12, G13

Suggested Citation

Ye, Xiaoxia, Applying Linear Realization Theory to HJM Markovian Representation (September 15, 2009). Available at SSRN: https://ssrn.com/abstract=1473705 or http://dx.doi.org/10.2139/ssrn.1473705

Xiaoxia Ye (Contact Author)

University of Liverpool Management School ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

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