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Are the dynamic linkages between the macroeconomy and asset prices time-varying?

  • Guidolin, Massimo
  • Ono, Sadayuki

We estimate a number of multivariate regime switching VAR models on a long monthly data set for eight variables that include excess stock and bond returns, the real T-bill yield, predictors used in the finance literature (default spread and the dividend yield), and three macroeconomic variables (inflation, real industrial production growth, and a measure of real money growth). Heteroskedasticity may be accounted for by making the covariance matrix a function of the regime. We find evidence of four regimes and of time-varying covariances. We provide evidence that the best in-sample fit is provided by a four state model in which the VAR(1) component fails to be regime-dependent. We interpret this as evidence that the dynamic linkages between financial markets and the macroeconomy have been stable over time. We show that the four-state model can be helpful in forecasting applications and to provide one-step ahead predicted Sharpe ratios.

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Article provided by Elsevier in its journal Journal of Economics and Business.

Volume (Year): 58 (2006)
Issue (Month): 5-6 ()
Pages: 480-518

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Handle: RePEc:eee:jebusi:v:58:y:2006:i:5-6:p:480-518
Contact details of provider: Web page: http://www.elsevier.com/locate/jeconbus

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