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Estimation of Markov regime-switching regression models with endogenous switching

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Author Info
Kim, Chang-Jin
Piger, Jeremy
Startz, Richard

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Abstract

Following Hamilton [1989. A new approach to the economic analysis of nonstationary time series and the business cycle. Econometrica 57, 357-384], estimation of Markov regime-switching regressions typically relies on the assumption that the latent state variable controlling regime change is exogenous. We relax this assumption and develop a parsimonious model of endogenous Markov regime-switching. Inference via maximum likelihood estimation is possible with relatively minor modifications to existing recursive filters. The model nests the exogenous switching model, yielding straightforward tests for endogeneity. In Monte Carlo experiments, maximum likelihood estimates of the endogenous switching model parameters were quite accurate, even in the presence of certain model misspecifications. As an application, we extend the volatility feedback model of equity returns given in Turner et al. [1989. A Markov model of heteroskedasticity, risk, and learning in the stock market. Journal of Financial Economics 25, 3-22] to allow for endogenous switching.

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File URL: http://www.sciencedirect.com/science/article/B6VC0-4R0KTFP-1/1/fb008e0cfab789848e0e57aa6b2653cd
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Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 143 (2008)
Issue (Month): 2 (April)
Pages: 263-273
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Handle: RePEc:eee:econom:v:143:y:2008:i:2:p:263-273

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Web page: http://www.elsevier.com/locate/jeconom

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Christopher M. Turner & Richard Startz & Charles R. Nelson, 1989. "A Markov Model of Heteroskedasticity, Risk, and Learning in the Stock Market," NBER Working Papers 2818, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Wu, De-Min, 1973. "Alternative Tests of Independence Between Stochastic Regressors and Disturbances," Econometrica, Econometric Society, vol. 41(4), pages 733-50, July. [Downloadable!] (restricted)
  3. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September. [Downloadable!] (restricted)
  4. John Y. Campbell & Ludger Hentschel, 1991. "No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns," NBER Working Papers 3742, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March. [Downloadable!] (restricted)
  6. Francis X. Diebold & Joon-Haeng Lee & Gretchen C. Weinbach, 1993. "Regime switching with time-varying transition probabilities," Working Papers 93-12, Federal Reserve Bank of Philadelphia.
  7. Michael T. Owyang, 2002. "Modeling Volcker as a non-absorbing state: agnostic identification of a Markov-switching VAR," Working Papers 2002-018, Federal Reserve Bank of St. Louis. [Downloadable!]
  8. Filardo, Andrew J, 1994. "Business-Cycle Phases and Their Transitional Dynamics," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 299-308, July.
  9. Bekaert, Geert & Wu, Guojun, 2000. "Asymmetric Volatility and Risk in Equity Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 13(1), pages 1-42.
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  10. Christopher Sims & Tao Zha, 2002. "Macroeconomic switching," Proceedings, Federal Reserve Bank of San Francisco, issue Mar. [Downloadable!]
  11. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70. [Downloadable!] (restricted)
  12. Goldfeld, Stephen M. & Quandt, Richard E., 1973. "A Markov model for switching regressions," Journal of Econometrics, Elsevier, vol. 1(1), pages 3-15, March. [Downloadable!] (restricted)
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  1. Siddhartha Chib & Michael J. Dueker, 2004. "Non-Markovian regime switching with endogenous states and time-varying state strengths," Working Papers 2004-030, Federal Reserve Bank of St. Louis. [Downloadable!]
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