Calculating Risk Free Rate of Return In Iranian Financial Market Using Kalman-Filter Method



The risk free rate of return plays a main role in financial economic theory and financial markets. Due to prohibition of interest in Islamic countries there is no specific financial instrument with risk free rate of return as a criterion for measuring the risk free rate of market. We apply the Kalman Filter to estimate this variable for financial markets in Iran. The technique is based on a state space representation derived from capital asset pricing model (CAPM) and one of the Random Walk or Autoregressive models. The parameters of the model are estimated by maximum likelihood. We generally found that the AR (1) is an optimum model for Rf , and the mean, variance, and final state of the estimated variable are 0.0397, 0.0005, and 0.036 respectively.
JEL Classification: G12, C32