Volatility Forecasting with Double Markov Switching GARCH Models

21 Pages Posted: 27 May 2009

See all articles by Cathy W. S. Chen

Cathy W. S. Chen

Feng Chia University - Department of Statistics; Graduate Institute of Statistics & Actuarial Science, Feng Chia University

Mike K. P. So

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics & Operations Management

Edward M.H. Lin

Graduate Institute of Applied Statistics, Feng Chia University

Date Written: May 27, 2009

Abstract

This paper investigates inference and volatility forecasting using a Markov switching heteroscedastic model with a fat-tailed error distribution to analyze asymmetric effects on both the conditional mean and conditional volatility of financial time series. The motivation for extending the Markov switching GARCH model, previously developed to capture mean asymmetry, is that the switching variable, assumed to be a first-order Markov process, is unobserved. The proposed model extends this work to incorporate Markov switching in the mean and variance simultaneously. Parameter estimation and inference are performed in a Bayesian framework via a Markov chain Monte Carlo scheme. We compare competing models using Bayesian forecasting in a comparative value-at-risk study. The proposed methods are illustrated using both simulations and eight international stock market return series. The results generally favor the proposed double Markov switching GARCH model with an exogenous variable.

Keywords: heteroscedastic models, Markov chain Monte Carlo, regime-switching models, value at risk, volatility

JEL Classification: C11, C15, C22, C51, C52

Suggested Citation

Chen, Cathy W. S. and So, Mike K.P. and Lin, Edward M.H., Volatility Forecasting with Double Markov Switching GARCH Models (May 27, 2009). Available at SSRN: https://ssrn.com/abstract=1410581 or http://dx.doi.org/10.2139/ssrn.1410581

Cathy W. S. Chen

Feng Chia University - Department of Statistics ( email )

100 Wen Hwa Road
Taichung, 407
Taiwan
886 4 24517250 ext 4412 (Phone)
886 4 24517092 (Fax)

HOME PAGE: http://myweb.fcu.edu.tw/~chenws/

Graduate Institute of Statistics & Actuarial Science, Feng Chia University

100 Wenhwa Road
Talchung
Taiwan
886 4-24517250 ext 4412 (Phone)
886 4-2517092 (Fax)

HOME PAGE: http://myweb.fcu.edu.tw/~chenws/

Mike K.P. So

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics & Operations Management ( email )

Clear Water Bay, Kowloon
Hong Kong

Edward M.H. Lin (Contact Author)

Graduate Institute of Applied Statistics, Feng Chia University ( email )

100 Wen Hwa Road
Taichung, 407
Taiwan

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