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Application of teh Kalman Filter to Interest Rate Modelling

Ibhagui, Oyakhilome (2010): Application of teh Kalman Filter to Interest Rate Modelling. Published in: Essays towards the AIMS Postgraduate Diploma 2009-10

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Abstract

We give a mild introduction to the Kalman filter and the generalized Vasicek models of the term structure of interest rates with special attention to the application of the Kalman filter equations to one-and two-factor models. After thoroughly reviewing the essential tools that constitute the Kalman filter and the generalized Vasicek models of the term structure of interest rates, we derive the yield on a zero coupon bond with infinite maturity and the Kalman �filter equations of the state space formulation of the generalized Vasicek models. By performing simulations, we illustrate how the Kalman �filter works and the major weakness of the Vasicek model.

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