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

57 Pages Posted: 26 Aug 2001 Last revised: 23 Mar 2002

See all articles by Pedro Santa-Clara

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Michael W. Brandt

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Date Written: August 2001

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.

Suggested Citation

Santa-Clara, Pedro and Brandt, Michael W., Simulated Likelihood Estimation of Diffusions with an Application to Exchange Rate Dynamics in Incomplete Markets (August 2001). NBER Working Paper No. t0274. Available at SSRN: https://ssrn.com/abstract=281069

Pedro Santa-Clara

New University of Lisbon - Nova School of Business and Economics ( email )

Lisbon
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~psc/

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Michael W. Brandt (Contact Author)

Duke University - Fuqua School of Business ( email )

1 Towerview Drive
Durham, NC 27708-0120
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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