R: Data Analysis and Visualization

Parameter estimation of interest rate models

When using the interest rate models for pricing or simulation purposes, it is important to calibrate their parameters to real data properly. Here, we present a possible method to estimate the parameters. This method was developed by Chan et al, 1992, and is often referred to as the CKLS method. The procedure was elaborated to estimate the parameters of the following interest rate model with the help of the econometric procedure called Generalized Method of Moments (GMM; see Hansen, 1982, for more details):

It is easy to see that this process gives the Vasicek model when γ=0, and the CIR model when γ =0.5. ...