QuoteOriginally posted by: outrunThis is my guess:A SDE (is that the model?) has well defined parameter, and that definition is the interface between calibration and simulation. You can have various algorithm that estimate the SDE parameters given all sort of data (historical data, implied vol data) and all sort of calibration methods (least squares, maximum likelihood, constraint optimized like "all forward rates need to be positive" etc etc).That calibration is orthogonal to the MC simulation and a world on its own. The MC engine needs SDE parameter values as input, and it doesn't care if those are based on calibration or eg a manual picked stress scenario by a risk manager.For the MC framework you can forget about the calibration and assume the SDE parameters as given/input.Yes, I agree.A SDE (is that the model?) has well defined parameter, and that definition is the interface between calibration and simulation2 interfaces 1) to upper pricer , 2) possibly to lower market/simulated data. In fact, you have answered my previous:0) the SDE is just a class that models sdes with drift, diffusion etc. More detailed layered designs allows you to initialise them using MLE etc. (like your OU calibration paper). Is that what you mean?
Last edited by Cuchulainn
on January 20th, 2014, 11:00 pm, edited 1 time in total.