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Business Cycle and Stock Market Volatility: A Particle Filter Approach

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  • Casarin, Roberto
  • Trecroci, Carmine

Abstract

The recent observed decline of business cycle variability suggests that broad macroeconomic risk may have fallen as well. This may in turn have some impact on equity risk premia. We investigate the latent structures in the volatilities of the business cycle and stock market valuations by estimating a Markov switching stochastic volatility model. We propose a sequential Monte Carlo technique for the Bayesian inference on both the unknown parameters and the latent variables of the hidden Markov model. Sequential importance sampling is used for filtering the latent variables and kernel estimator with a multiple-bandwidth is employed to reconstruct the parameter posterior distribution. We find that the switch to lower variability has occurred in both business cycle and stock market variables along similar patterns.

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Bibliographic Info

Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/6830.

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Date of creation: 2006
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Publication status: Published in Cahiers du CEREMADE, 2006
Handle: RePEc:dau:papers:123456789/6830

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Keywords: Markov Switching; Stochastic Volatility; Business Cycle; Equity Market; Particle Filters; Sequential Monte Carlo;

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  1. Martin Lettau & Sydney C. Ludvigson, 2004. "The Declining Equity Premium: What Role Does Macroeconomic Risk Play?," 2004 Meeting Papers 644, Society for Economic Dynamics.
  2. Rosella Nicolini & Francesco Menoncin, 2005. "The optimal behaviour of firms facing stochastic costs," UFAE and IAE Working Papers 640.05, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  3. Chopin, Nicolas & Pelgrin, Florian, 2004. "Bayesian inference and state number determination for hidden Markov models: an application to the information content of the yield curve about inflation," Journal of Econometrics, Elsevier, vol. 123(2), pages 327-344, December.
  4. Francesco Menoncin & Marco Tronzano, . "Optimal real exchange rate targeting: a stochastic analysis," Working Papers ubs0401, University of Brescia, Department of Economics.
  5. Michele Polo & Carlo Scarpa, 2003. "Entry Without Competition," Working Papers 245, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  6. Margaret M. McConnell & Gabriel Perez Quiros, 1998. "Output fluctuations in the United States: what has changed since the early 1980s?," Staff Reports 41, Federal Reserve Bank of New York.
  7. Chiara Dalla Nogare & Roberto Ricciuti, . "Chief Executives' Term Limits and Fiscal Policy Choices: International Evidence," Working Papers ubs0411, University of Brescia, Department of Economics.
  8. Mark W. Watson, 1992. "Business Cycle Durations and Postwar Stabilization of the U.S. Economy," NBER Working Papers 4005, National Bureau of Economic Research, Inc.
  9. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
  10. Sydney Ludvigson & Martin Lettau, 1999. "Consumption, aggregate wealth and expected stock returns," Staff Reports 77, Federal Reserve Bank of New York.
  11. Nicolas Chopin, 2001. "Sequential Inference and State Number Determination for Discrete State-Space Models through Particle Filtering," Working Papers 2001-34, Centre de Recherche en Economie et Statistique.
  12. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
  13. Monica Billio & Roberto Casarin & Domenico Sartore, 2007. "Bayesian Inference on Dynamic Models with Latent Factors," Working Papers 2007_34, Department of Economics, University of Venice "Ca' Foscari".
  14. Michele Moretto & Paola Valbonesi, . "Dynamic Firm Regulation with Endogenous Profit-Sharing," Working Papers ubs0410, University of Brescia, Department of Economics.
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