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Abstract

We propose a parsimonious regime switching model to characterize the dynamics in the volatilities and correlations of US deposit banks' stock returns over 1994-2011. A first innovative feature of the model is that the within-regime dynamics in the volatilities and correlation depend on the shape of the Student t innovations. Secondly, the across-regime dynamics in the transition probabilities of both volatilities and correlations are driven by macro-financial indicators such as the Saint Louis Financial Stability index, VIX or TED spread. We find strong evidence of time-variation in the regime switching probabilities and the within-regime volatility of most banks. The within-regime dynamics of the equicorrelation seem to be constant over the period.

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File URL: http://www.nbb.be/doc/oc/repec/reswpp/wp227En.pdf
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Bibliographic Info

Paper provided by National Bank of Belgium in its series Working Paper Research with number 227.

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Length: 54 pages
Date of creation: Oct 2012
Date of revision:
Handle: RePEc:nbb:reswpp:201210-227

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This paper has been announced in the following NEP Reports:

• NEP-ALL-2012-10-20 (All new papers)
• NEP-BAN-2012-10-20 (Banking)
• NEP-ECM-2012-10-20 (Econometrics)
• NEP-ETS-2012-10-20 (Econometric Time Series)
• NEP-RMG-2012-10-20 (Risk Management)

References

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    • Pelletier, Denis, 2006. "Regime switching for dynamic correlations," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 445-473.
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Cited by:

1. H. Dewachter & G. de Walque & M. Emiris & P. Ilbas & J. Mitchell & R. Wouters, 2012. "Endogenous financial risk : The seventh international conference of the NBB," Economic Review, National Bank of Belgium, issue III, pages 135-146, December.
2. L. Bauwens & E. Otranto, 2013. "Modeling the Dependence of Conditional Correlations on Volatility," Working Paper CRENoS 201304, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.

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