Regime Switching Volatility Calibration by the Baum-Welch Method
Statistical Finance
2009-04-10 v1 Computational Finance
Abstract
Regime switching volatility models provide a tractable method of modelling stochastic volatility. Currently the most popular method of regime switching calibration is the Hamilton filter. We propose using the Baum-Welch algorithm, an established technique from Engineering, to calibrate regime switching models instead. We demonstrate the Baum-Welch algorithm and discuss the significant advantages that it provides compared to the Hamilton filter. We provide computational results of calibrating the Baum-Welch filter to S&P 500 data and validate its performance in and out of sample.
Cite
@article{arxiv.0904.1500,
title = {Regime Switching Volatility Calibration by the Baum-Welch Method},
author = {Sovan Mitra},
journal= {arXiv preprint arXiv:0904.1500},
year = {2009}
}