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Zbl 1035.62084
Frydman, Halina; Lakner, Peter
Maximum likelihood estimation of hidden Markov processes.
(English)
[J] Ann. Appl. Probab. 13, No. 4, 1296-1312 (2003). ISSN 1050-5164

Summary: We consider the process $dY_t=u_t dt+dW_t$, where $u$ is a process not necessarily adapted to ${\Cal F}^Y$ (the filtration generated by the process $Y)$ and $W$ is a Brownian motion. We obtain a general representation for the likelihood ratio of the law of the $Y$ process relative to a Brownian measure. This representation involves only one basic filter (expectation of $u$ conditional on the observed process $Y)$. This generalizes a result of {\it T. Kailath} and {\it M. Zakai} [Ann. Math. Stat. 42, 130--140 (1971; Zbl 0226.60061)] where it is assumed that the process $u$ is adapted to ${\Cal F}^Y$.\par In particular, we consider the model in which $u$ is a functional of $Y$ and of a random element $X$ which is independent of the Brownian motion $W$. For example, $X$ could be a diffusion or a Markov chain. This result can be applied to the estimation of an unknown multidimensional parameter $\theta$ appearing in the dynamics of the process $u$ based on continuous observation of $Y$ on the time interval $[0,T]$.\par For a specific hidden diffusion financial model in which $u$ is an unobserved mean-reverting diffusion, we give an explicit form for the likelihood function of $\theta$. For this model we also develop a computationally explicit E-M algorithm for the estimation of $\theta$. In contrast to the likelihood ratio, the algorithm involves evaluation of a number of filtered integrals in addition to the basic filter.
MSC 2000:
*62M05 Markov processes: estimation
60J60 Diffusion processes
60J25 Markov processes with continuous parameter

Keywords: likelihood ratio; E-M algorithm; filtered integrals; drift estimation; security price process

Citations: Zbl 0226.60061

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