References (21)



Regime Changes in Stock Returns

Ramon P. DeGennaro

University of Tennessee, Knoxville - Department of Finance

Nan-Ting Chou

University of Louisville - College of Business - Department of Economics

This paper models stock returns as a function of three components: a constant expected return, the impact of the mechanism for executing trades, and a rational expectations error. We examine changes in these parameters using Goldfeld and Quandt's (1976) deterministic switching based on time. This method not only allows us to learn if and when the regression structure changes, but also provides a measure of the speed of transition from one regime to the other. We find that, regardless of the sample period, all regime shifts are due to changes in the estimated variance of the error. This is true even if the ex post return on the stock portfolio or the estimated rate of compensation for financing costs changes substantially. In addition, these structural shifts occur during substantial changes in the business environment, driven by important political decisions. We interpret these findings as suggesting that government policy strongly affects the volatility of the stock market.

Number of Pages in PDF File: 14

Keywords: regime changes, stock returns, switching regression, volatility

JEL Classification: G1, G2, N2, H8

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Date posted: April 8, 2003  

Suggested Citation

DeGennaro, Ramon P. and Chou, Nan-Ting, Regime Changes in Stock Returns. Available at SSRN: http://ssrn.com/abstract=376600 or http://dx.doi.org/10.2139/ssrn.376600

Contact Information

Ramon P. DeGennaro (Contact Author)
University of Tennessee, Knoxville - Department of Finance ( email )
423 Stokely Management Center
Knoxville, TN 37996
United States
865-974-1726 (Phone)
865-974-1716 (Fax)
Nan-Ting Chou
University of Louisville - College of Business - Department of Economics ( email )
Louisville, KY 40292
United States
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References:  21

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