Interview Question: Rocket Science

Sample Question #16 (applied math – control theory)
The latest "hot" topic in financial research is using the Kalman filter in various applications. Can you explain the basic idea behind the Kalman filter (i.e., what does the filter try to do with the data)? Can you write the basic Kalman filter model? What are some of the applications of the Kalman filter?
Tough question: How do you estimate (or implement) the Kalman filter? For example, to study stock price movement.
(Comment: it definitely pays to read up on the basics of the Kalman filter; a good introduction for non-engineers can be found in Tsay’s Analysis of Financial Time Series)
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