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Regime-Switching Stock Returns And Mean Reversion

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  • Nielsen, Steen

    (Department of Economics, Copenhagen Business School)

  • Olesen, Jan Overgaard

    (Department of Economics, Copenhagen Business School)

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    Abstract

    We estimate a well-specified two-state regime-switching model for Danish stock returns. The model identifies two regimes which have low return-low volatility and high return-high volatility, respectively. The low return-low volatility regime dominated, except in a few, short episodes, until the beginning of the 70s whereas the 80s and 90s have been characterized by high return and high volatility. We propose an alternative test of mean reversion which allows for multiple regimes with potentially different constant and autoregressive terms and different volatility. Using this test procedure we find mean reversion at 10% but not at 5% significance level which is weaker evidence than produced by estimating a standard autoregressive model for returns. Furthermore, when analyzing contributions of the two regimes we find that the indication of mean reversion is due to the recent high return-high volatility regime only.

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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7529
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    Bibliographic Info

    Paper provided by Copenhagen Business School, Department of Economics in its series Working Papers with number 11-2000.

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    Length: 31 pages
    Date of creation: 12 Jul 2001
    Date of revision:
    Handle: RePEc:hhs:cbsnow:2000_011

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    Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark
    Phone: 38 15 25 75
    Fax: 38 15 34 99
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    Web page: http://www.cbs.dk/departments/econ/
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    Related research

    Keywords: Regime-Switching; Stock returns; Mean reversion; Denmark;

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    1. Kim, Myung Jig & Nelson, Charles R & Startz, Richard, 1991. "Mean Reversion in Stock Prices? A Reappraisal of the Empirical Evidence," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 515-28, May.
    2. Kim, Chang-Jin & Nelson, Charles R. & Startz, Richard, 1998. "Testing for mean reversion in heteroskedastic data based on Gibbs-sampling-augmented randomization1," Journal of Empirical Finance, Elsevier, vol. 5(2), pages 131-154, June.
    3. Hamilton, James D., 1996. "Specification testing in Markov-switching time-series models," Journal of Econometrics, Elsevier, vol. 70(1), pages 127-157, January.
    4. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
    5. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
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