Regime Changes and Financial Markets
Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)
Allan G. Timmermann
University of California, San Diego (UCSD) - Department of Economics; Centre for Economic Policy Research (CEPR)
June 20, 2011
Netspar Discussion Paper No. 06/2011-068
Regime switching models can match the tendency of financial markets to often change their behavior abruptly and the phenomenon that the new behavior of financial variables often persists for several periods after such a change. While the regimes identified by regime switching models are identified by an econometric procedure, they often intuitively match different periods in regulation, policy, and other secular changes. In empirical estimates, the regime switching means, volatilities, autocorrelations, and cross-covariances of asset returns often differ across regimes, which allow regime switching models to capture the stylized behavior of many financial series including fat tails, heteroskedasticity, skewness, and time-varying correlations. In equilibrium models, regimes in fundamental processes, like consumption or dividend growth, strongly affect the dynamic properties of equilibrium asset prices and can induce non-linear risk-return trade-offs. Regime switches also lead to potentially large consequences for investors’ optimal portfolio choice.
Number of Pages in PDF File: 34
Keywords: regime switching, non-linear equilibrium asset pricing models, mixture distributions rare events, jumps
JEL Classification: G11, G12
Date posted: August 30, 2011
© 2016 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollobot1 in 0.250 seconds