COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1309

Gaussian Estimation of Continuous Time Models of the Short Term Interest Rate

Jun Yu and Peter C.B. Phillips

July 2001

This paper proposes a Gaussian estimator for nonlinear continuous time models of the short term interest rate. The approach is based on a stopping time argument that produces a normalizing transformation facilitating the use of a Gaussian likelihood. A Monte Carlo study shows that the finite sample performance of the proposed procedure offers an improvement over the discrete approximation method proposed by Nowman (1997). An empirical application to U.S. and British interest rates is given.

Keywords: Gaussian estimation, nonlinear diffusion, normalizing transformation

JEL Classification: C14, C22, G12