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Simulated Likelihood Estimation of Diffusions with an Application to Exchange Rate Dynamics in Incomplete Markets

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Author Info
Michael W. Brandt
Pedro Santa-Clara
Abstract

We present an econometric method for estimating the parameters of a diffusion model from discretely sampled data. The estimator is transparent, adaptive, and inherits the asymptotic properties of the generally unattainable maximum likelihood estimator. We use this method to estimate a new continuous-time model of the Joint dynamics of interest rates in two countries and the exchange rate between the two currencies. The model allows financial markets to be incomplete and specifies the degree of incompleteness as a stochastic process. Our empirical results offer several new insights into the dynamics of exchange rates.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0274.

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Date of creation: Aug 2001
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Handle: RePEc:nbr:nberte:0274

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G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Michael Brandt & John Cochrane & Pedro Santa-Clara, 2001. "International Risk Sharing is Better Than You Think (or Exchange Rates are Much Too Smooth!," University of California at Los Angeles, Anderson Graduate School of Management 1015, Anderson Graduate School of Management, UCLA. [Downloadable!]
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