1. A method for detecting a failure or performance degradation in a dynamic system having sensors for measuring state variables of the system and providing corresponding output signals in response to at least one system input signal, the method comprising: calculating estimated gains of a filter and selecting an appropriate linear model for processing the output signals based on the at least one system input signal, the step of calculating utilizing at least one model of the dynamic system to obtain estimated signals; calculating output error residuals based on the output signals and the estimated signals; and detecting at least one hypothesized failure or performance degradation of a component or subsystem of the dynamic system based on the error residuals, wherein the step of calculating the estimated gains is performed optimally with respect to one or more of: noise, uncertainty of parameters of the at least one model and un-modeled dynamics of the dynamic system.