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Business Cycle and Stock Market Volatility: A Particle Filter Approach

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  • Roberto Casarin
  • Carmine Trecroci

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 University of Brescia, Department of Economics in its series Working Papers with number ubs0603.

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Date of creation: 2006
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Handle: RePEc:ubs:wpaper:ubs0603

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  1. Francesco Menoncin & Marco Tronzano, 2007. "Optimal Real Exchange Rate Targeting. A Stochastic Analysis," Revue économique, Presses de Sciences-Po, vol. 58(4), pages 807-840.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1997. "Monetary Policy Rules in Practice: Some International Evidence," CEPR Discussion Papers 1750, C.E.P.R. Discussion Papers.
  3. Mark W. Watson, 1992. "Business cycle durations and postwar stabilization of the U.S. economy," Working Paper Series, Macroeconomic Issues 92-6, Federal Reserve Bank of Chicago.
  4. Michele Polo & Carlo Scarpa, 2003. "Entry Without Competition," Working Papers 245, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  5. Martin Lettau & Sydney C. Ludvigson & Jessica A. Wachter, 2008. "The Declining Equity Premium: What Role Does Macroeconomic Risk Play?," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1653-1687, July.
  6. Francesco Menoncin & Rosella Nicolini, 2005. "The optimal behaviour of firms facing stochastic costs," Working Papers ubs0501, University of Brescia, Department of Economics.
  7. Gabriel Perez-Quiros & Margaret M. McConnell, 2000. "Output Fluctuations in the United States: What Has Changed since the Early 1980's?," American Economic Review, American Economic Association, vol. 90(5), pages 1464-1476, December.
  8. Sydney Ludvigson & Martin Lettau, 1999. "Consumption, aggregate wealth and expected stock returns," Staff Reports 77, Federal Reserve Bank of New York.
  9. Michele Moretto & Paola Valbonesi, . "Dynamic Firm Regulation with Endogenous Profit-Sharing," Working Papers ubs0410, University of Brescia, Department of Economics.
  10. 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.
  11. Chiara Dalla Nogare & Roberto Ricciuti, . "Chief Executives' Term Limits and Fiscal Policy Choices: International Evidence," Working Papers ubs0411, University of Brescia, Department of Economics.
  12. 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.
  13. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
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