An Econometric Model of Nonlinear Dynamics in the Joint Distribution of Stock and Bond Returns
37 Pages Posted: 27 Aug 2004
Date Written: July 2004
This paper considers a variety of econometric models for the joint distribution of US stock and bond returns in the presence of regime switching dynamics. While simple two- or three-state models capture the univariate dynamics in bond and stock returns, a more complicated four state model with regimes characterized as crash, slow growth, bull and recovery states is required to capture their joint distribution. The transition probability matrix of this model has a very particular form. Exits from the crash state are almost always to the recovery state and occur with close to 50 percent chance suggesting a bounce-back effect from the crash to the recovery state.
Keywords: Regime switching, stock and bond return predictability, nonlinear modeling
JEL Classification: C32, G12, G51
Suggested Citation: Suggested Citation