Michael Johannes

Optimal Filtering of Jump Diffusions: Extracting Latent States from Asset Prices

Coauthor(s): Nicholas Polson, Jonathan Stroud.

Abstract:
This paper provides an optimal filtering methodology in discretely observed continuous-time jump-diffusion models. Although the filtering problem has received little attention, it is useful for estimating latent states, forecasting volatility and returns, computing model diagnostics such as likelihood ratios, and parameter estimation. Our approach combines time-discretization schemes with Monte Carlo methods. It is quite general, applying in nonlinear and multivariate jump-diffusion models and models with nonanalytic observation equations. We provide a detailed analysis of the filter's performance, and analyze four applications: disentangling jumps from stochastic volatility, forecasting volatility, comparing models via likelihood ratios, and filtering using option prices and returns.

Source: The Review of Financial Studies
Exact Citation:
Johannes, Michael, Nicholas Polson, and Jonathan Stroud. "Optimal Filtering of Jump Diffusions: Extracting Latent States from Asset Prices." The Review of Financial Studies 22, no. 7 (2009): 2759-2799.
Volume: 22
Number: 7
Pages: 2759-2799
Date: 2009