MCMC Methods for Continuous-Time Financial Econometrics
Michael S. Johannes
Columbia Business School - Finance and Economics
University of Chicago - Booth School of Business
December 22, 2003
This chapter develops Markov Chain Monte Carlo (MCMC) methods for Bayesian inference in continuous-time asset pricing models. The Bayesian solution to the inference problem is the distribution of parameters and latent variables conditional on observed data, and MCMC methods provide a tool for exploring these high-dimensional, complex distributions. We first provide a description of the foundations and mechanics of MCMC algorithms. This includes a discussion of the Clifford-Hammersley theorem, the Gibbs sampler, the Metropolis-Hastings algorithm, and theoretical convergence properties of MCMC algorithms. We next provide a tutorial on building MCMC algorithms for a range of continuous-time asset pricing models. We include detailed examples for equity price models, option pricing models, term structure models, and regime-switching models. Finally, we discuss the issue of sequential Bayesian inference, both for parameters and state variables.
Number of Pages in PDF File: 96
Date posted: December 27, 2003