A Simple Approach To The Estimation Of Continuous Time Cev Stochastic Volatility Models Of The Short Term Rate PDF Download

Aim of this article is to judge the empirical performance of Arch as diffusion approximations to models of the short-term rate with stochastic volatility and as filters of the unobserved volatility. We show that the estimation of the continuous time scheme to which a discrete time Arch model converges can be safely based on simple moment conditions linking the discrete time to the continuous time coefficients. A natural substitute of a global specification test for just-identified problems based on indirect inference shows in fact that this approximation to diffusions gives rise to a negligible disaggregation bias. Unlike previous literature in which standard Arch models approximated only specific diffusions, our estimation strategy relies on a new Arch model that approximates any CEV-diffusion model for the conditional volatility. A Monte-Carlo study reveals that the filtering performances of this model are remarkably good, even in the presence of an important kind of misspecification.