Not All Bull and Bear Markets Are Alike: Insights From a Five-State Hidden Semi-Markov Model
26 Pages Posted: 21 Sep 2020
Date Written: August 20, 2020
This paper employs the hidden semi-Markov model and a novel model selection procedure to detect different states in the US stock market. The empirical results suggest that the market is switching between five states that can be classified into three bull states and two bear states. The three bull states are categorized as a low volatility bull market, a high volatility bull market, and a stock market bubble. One of the bear states represents a regular bear market, while the other one corresponds to either a stock market crash or a market correction. The paper demonstrates that the five-state model is consistent with a number of stylized facts and provides many valuable insights into the dynamics of the US stock market. Besides, the five-state model has clear implications for the success of some active strategies that aim to enhance returns and reduce losses.
Keywords: semi-Markov models, stock market regimes, bull and bear markets, US stock market
JEL Classification: C22, G10
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