The Bayesian analysis of a state-space model includes computing the posterior distribution of the system’s parameters as well as its latent states. When the latent states wander around there are several well-known modeling components and computational tools that may be profitably combined to achieve this task. When the latent states are constrained to a strict subset of these models and tools are either impaired or break down completely. State-space models whose latent states are covariance matrices arise in finance and exemplify the challenge of devising tractable models in the constrained setting. To that end, we present a state-space model whose observations and latent states take values on the manifold of symmetric positive-definite matrices and for which one may easily compute the posterior distribution of the latent states and the system’s parameters as well as filtered distributions and one-step ahead predictions. Employing the model within the context of finance, we show how one can use realized covariance matrices as data to predict latent time-varying covariance matrices. This approach out-performs factor stochastic volatility.
"A Tractable State-Space Model for Symmetric Positive-Definite Matrices." Bayesian Anal. 9 (4) 759 - 792, December 2014. https://doi.org/10.1214/14-BA888