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This article presents the first application in finance of recently developed methods for the Gaussian estimation of continuous time dynamic models. A range of one factor continuous time models of the short‐term interest rate are estimated using a discrete time model and compared to a recent discrete approximation used by Chan, Karolyi, Longstaff, and Sanders (1992a, hereafter CKLS). Whereas the volatility of short‐term rates is highly sensitive to the level of rates in the United States, it is not in the United Kingdom.

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Over the last thirty years there has been extensive use of continuous time econometric methods in macroeconomic modeling. This monograph presents the first continuous time macroeconometric model of the United Kingdom incorporating stochastic trends. Its development represents a major step forward in continuous time macroeconomic modeling. The book describes the new model in detail and, like earlier models, it is designed in such a way as to permit a rigorous mathematical analysis of its steady state and stability properties, thus providing a valuable check on the capacity of the model to generate plausible long-run behavior. The model is estimated using newly developed exact Gaussian estimation method for continuous time econometric models incorporating unobservable stochastic trends. The book also includes discussion of the application of the model to dynamic analysis and forecasting.