Modelling UK Stock Returns: A Multiple-Regime Framework
33 Pages Posted: 14 Nov 2012
Date Written: August 19, 2007
Through the use of regime-switching models, recent empirical research has essentially demonstrated that the dynamics of stock returns depend on the state of one stock market. The present paper extends this analytical framework by allowing the dynamics of returns to depend on the joint-states of two different stock markets. Such an extension is natural given the globalisation of financial markets and the rapid transmission of news from one international stock market to another. In an application involving the S&P500, the FTSE100 and the NIKKEI225 over the period January 1984-October 2003, UK return dynamics are found to depend on the joint-states of the US and UK stock markets three months back. Moreover the contemporaneous dependence of UK stock returns on US stock returns increases with a rising US market and a falling UK market but decreases with a falling US market and a rising UK market. This is consistent with a ‘rapport de force’ effect whereby the relative strength of the US and UK stock markets matter in determining the degree of contemporaneous dependence of the UK stock market on the US stock market.
Keywords: Stock Returns, Multiple Regimes, Smooth Transition
JEL Classification: C51, C52
Suggested Citation: Suggested Citation