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Rational Expectations in a VAR with Markov Switching

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  • Blix, Mårten

    (Sveriges Riksbank)

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    Abstract

    This paper shows how a well known class of rational expectations hypotheses using linear vector autoregressions (VAR:s) can be extended to allow for unobservable Markov switching. The regime shift model used falls into the general framework of Hamilton (1990), but differs to the centered model actually implemented by Hamilton and others. The model here has the advantage that it is easier to estimate, and the intuitive appeal that the state dependence is symmetric. The contribution of the paper is to derive testable restrictions implied by rational expectations, which are linear when the forecast horizon is infinite. The restrictions on the autoregressive parameters are the same as those that appear in the centered model. As an illustration, we duplicate a test of the expectations hypothesis (EH) in Sola & Driffill (1994) on 3 and 6 month US bills on quarterly data, and find that their results may be fragile.

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    Bibliographic Info

    Paper provided by Stockholm University, Institute for International Economic Studies in its series Seminar Papers with number 627.

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    Length: 37 pages
    Date of creation: 31 Oct 1997
    Date of revision:
    Handle: RePEc:hhs:iiessp:0627

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    Related research

    Keywords: VAR; Markov chain; regime switching; rational expectations; expectations hypothesis;

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    References

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    1. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," NBER Working Papers 1885, National Bureau of Economic Research, Inc.
    2. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 307-333.
    3. Tauchen, George, 1985. "Diagnostic testing and evaluation of maximum likelihood models," Journal of Econometrics, Elsevier, vol. 30(1-2), pages 415-443.
    4. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
    5. Hamilton, James D., 1996. "Specification testing in Markov-switching time-series models," Journal of Econometrics, Elsevier, vol. 70(1), pages 127-157, January.
    6. Newey, Whitney K, 1985. "Maximum Likelihood Specification Testing and Conditional Moment Tests," Econometrica, Econometric Society, vol. 53(5), pages 1047-70, September.
    7. 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.
    8. Gregory, Allan W & Veall, Michael R, 1985. "Formulating Wald Tests of Nonlinear Restrictions," Econometrica, Econometric Society, vol. 53(6), pages 1465-68, November.
    9. Sola, Martin & Driffill, John, 1994. "Testing the term structure of interest rates using a stationary vector autoregression with regime switching," Journal of Economic Dynamics and Control, Elsevier, vol. 18(3-4), pages 601-628.
    10. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
    11. Baillie, R.T., 1988. "Econometric Tests Of Rationality And Market Efficiency," Papers 8805, Michigan State - Econometrics and Economic Theory.
    12. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
    13. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
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    Citations

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    Cited by:
    1. Nicolas Rautureau, 2004. "Modèles à changement de régime et test de la théorie des anticipations rationnelles de la structure par terme des taux d’intérêt en France," Économie et Prévision, Programme National Persée, vol. 163(2), pages 117-129.
    2. Beyaert, Arielle & Garcia-Solanes, Jose & Perez-Castejon, Juan J., 2007. "Uncovered interest parity with switching regimes," Economic Modelling, Elsevier, vol. 24(2), pages 189-202, March.

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