A Multifactor, Nonlinear, Continuous‐Time Model of Interest Rate Volatility*
This chapter provides a method for estimating multifactor continuous-time Markov processes. Using Milshtein's (1978) approximation schemes for writing expectations of functions of the sample path of stochastic differential equations in terms of the drift, volatility, and correlation coefficients, it provides nonparametric estimation of the drift and diffusion functions of multivariate stochastic differential equations. This technique is applied to the short- and long-end of the term structure for a general two-factor, continuous-time diffusion process for interest rates.
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