Why do we need Kalman Filtering theory in dynamic models in finance when we consider an environment of asymmetric or incomplete information? I understand that this has to do with the update of the probabilities based on the beliefs that traders have wrt to the assets payoffs, however I can not understand how the mechanism works. I tried the Wikipedia explanation, but it confused me more. Does anybody know a simple way to understand the intuition of the mechanism of Kalman Filtering? Is there some book or some simple model that I can take a lOok also to understand it better?
Kalman Filtering theory and application in Finance models under asymmetric or incomplete information
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1$\begingroup$ This is a great paper to understand Kalman Filter in the context of rate modeling. Basically, a Kalman Filter in this context let’s you take observable market data, like the 5 year zero coupon rate, and understand unobservable market data: the short rate. It took me such a long time before things clicked. I felt the same way when first exploring this subject. Stick through it! bankofcanada.ca/wp-content/uploads/2010/02/wp01-15a.pdf $\endgroup$– Mild_ThornberryJan 23, 2021 at 15:51
$\begingroup$ Thank you very much @Mild_Thornberry $\endgroup$– Hunger LearnJan 23, 2021 at 16:08
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