Bayesian Markov Switching Stochastic Correlation Models

53 Pages Posted: 8 Jun 2013

See all articles by Roberto Casarin

Roberto Casarin

University Ca' Foscari of Venice - Department of Economics

Marco Tronzano

Università degli Studi di Genova

Domenico Sartore

Ca Foscari University of Venice - Dipartimento di Economia

Date Written: June 1, 2013

Abstract

This paper builds on Asai and McAleer (2009) and develops a new multivariate Dynamic Conditional Correlation (DCC) model where the parameters of the correlation dynamics and those of the log-volatility process are driven by two latent Markov chains. We outline a suitable Bayesian inference procedure, based on sequential MCMC estimation algorithms, and discuss some preliminary results on simulated data. We then apply the model to three major cross rates against the US Dollar (Euro, Yen, Pound), using high-frequency data since the beginning of the European Monetary Union. Estimated volatility paths reveal significant increases since mid-2007, documenting the destabilizing effects of the US sub-prime crisis and of the European sovereign debt crisis. Moreover, we find strong evidence supporting the existence of a time-varying correlation structure. Correlation paths display frequent shifts along the whole sample, both in low and in high volatility phases, pointing out the existence of contagion effects closely in line with the mechanisms outlined in the recent contagion literature (Forbes and Rigobon (2002) and Corsetti at al. (2005)).

Keywords: Stochastic Correlation, Multivariate Stochastic Volatility, Markov-switching, Bayesian Inference, Monte Carlo Markov Chain

JEL Classification: C1, C11, C15, C32, F31, G15

Suggested Citation

Casarin, Roberto and Tronzano, Marco and Sartore, Domenico, Bayesian Markov Switching Stochastic Correlation Models (June 1, 2013). University Ca' Foscari of Venice, Dept. of Economics Research Paper Series No. 11/WP/2013. Available at SSRN: https://ssrn.com/abstract=2275754 or http://dx.doi.org/10.2139/ssrn.2275754

Roberto Casarin (Contact Author)

University Ca' Foscari of Venice - Department of Economics ( email )

San Giobbe 873/b
Venice, 30121
Italy
+39 030.298.91.49 (Phone)
+39 030.298.88.37 (Fax)

HOME PAGE: http://venus.unive.it/r.casarin/

Marco Tronzano

Università degli Studi di Genova

Via Vivaldi 5
Genova, 16126
Italy

Domenico Sartore

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

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