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Working Paper
Specifying a consistent joint maximum-likelihood (JMLE) approach to testing bond models
In this paper we extend the results derived in our earlier work to develop a methodology to employ the maximum-likelihood estimation technique for the pricing of interest rate instruments. In order to price bonds and their derivative assets, researchers must identify a preference parameter in addition to the dynamics for the interest rate process. There are two approaches to obtaining estimators for both preference and dynamics parameters: (1) a two-stage approach and (2) a single-stage joint maximum-likelihood (JMLE) approach. The first approach, while tractable, suffers from serious ...
Working Paper
MLE is alive and well in the financial markets
In this paper we specify the basic set of economic criteria that any diffusion-driven interest rate or FX rate process must satisfy. We also develop the methodology that is implementable to test the validity of a proposed process insofar as it satisfies the basic criteria as well as the actual estimation of the parameters of an acceptable candidate process. In this paper we focus on processes such as the overnight repo rate process or the FX rate process, each of which is directly observable. We develop what we call the marginal maximum-likelihood estimation (MMLE) technique to distinguish it ...
Working Paper
Applying economic restrictions to foreign exchange rate dynamics: spot rates, futures, and options
Extant models of exchange rate behavior have typically relied on statistical rather than economic considerations. The approach has been to employ a variant of the generalized central limit theorem to develop tests for the models proposed. ; We propose a minimal set of simple economic restrictions symmetry, invariance, and non-negativity that must be satisfied by an exchange rate process. By symmetry, we mean that both the direct and indirect exchange rate processes must belong to the same class of distributions. By invariance, we mean that the distribution for an exchange rate must be ...