IDEAS home Printed from https://ideas.repec.org/a/eee/reveco/v18y2009i2p306-317.html
   My bibliography  Save this article

Application of hidden Markov switching moving average model in the stock markets: Theory and empirical evidence

Author

Listed:
  • Lin, Shih-Kuei
  • Wang, Shin-Yun
  • Tsai, Pei-Ling

Abstract

In this paper, we propose a hidden Markov switching moving average model (MS-MA model) to extend the moving average model when the dynamic process of stock returns is predictable. That is, hidden Markov chain can be utilized to better describe the stock return dynamics when moving averages are correlated. Based on the MS-MA model, a recursive method of EM algorithm for parameter estimation is proposed and a numerical analysis is demonstrated. Furthermore, we empirically test the hidden Markov chain model using Dow Jones thirty stocks' data. The empirical results show that the dynamic process of stock returns exhibits MS-MA property, meaning the moving averages of stock returns are correlated. Therefore, the MS-MA model allows us to better understand and to predict stock return stochastic process. This model also helps in pricing equity derivatives.

Suggested Citation

  • Lin, Shih-Kuei & Wang, Shin-Yun & Tsai, Pei-Ling, 2009. "Application of hidden Markov switching moving average model in the stock markets: Theory and empirical evidence," International Review of Economics & Finance, Elsevier, vol. 18(2), pages 306-317, March.
    • Handle: RePEc:eee:reveco:v:18:y:2009:i:2:p:306-317
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1059-0560(08)00073-7
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Steve Beveridege & Cyril Oickle, 1997. "Long memory in the Canadian stock market," Applied Financial Economics, Taylor & Francis Journals, vol. 7(6), pages 667-672.
    2. Jegadeesh, Narasimhan, 1991. "Seasonality in Stock Price Mean Reversion: Evidence from the U.S. and the U.K," Journal of Finance, American Finance Association, vol. 46(4), pages 1427-1444, September.
    3. Cassano, Mark A., 1999. "Learning and mean reversion in asset returns," The Quarterly Review of Economics and Finance, Elsevier, vol. 39(4), pages 529-545.
    4. Chen, Carl R. & Su, Yuli & Huang, Ying, 2008. "Hourly index return autocorrelation and conditional volatility in an EAR-GJR-GARCH model with generalized error distribution," Journal of Empirical Finance, Elsevier, vol. 15(4), pages 789-798, September.
    5. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, vol. 22(1), pages 27-59, October.
    6. 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.
    7. Donald L. Martin, 1975. "Interest Rates and Occupational Choice," Journal of Human Resources, University of Wisconsin Press, vol. 10(4), pages 537-543.
    8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    9. Patricia Chelley-Steeley, 2001. "Mean Reversion in the Short Horizon Returns of UK Portfolios," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 28(1-2), pages 107-126.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Wang, Jianzhou & Zhu, Wenjin & Zhang, Wenyu & Sun, Donghuai, 2009. "A trend fixed on firstly and seasonal adjustment model combined with the [epsilon]-SVR for short-term forecasting of electricity demand," Energy Policy, Elsevier, vol. 37(11), pages 4901-4909, November.
    2. Guo, Haifeng & Brooks, Robert & Shami, Roland, 2010. "Detecting hot and cold cycles using a Markov regime switching model--Evidence from the Chinese A-share IPO market," International Review of Economics & Finance, Elsevier, vol. 19(2), pages 196-210, April.
    3. Farias Nazário, Rodolfo Toríbio & e Silva, Jéssica Lima & Sobreiro, Vinicius Amorim & Kimura, Herbert, 2017. "A literature review of technical analysis on stock markets," The Quarterly Review of Economics and Finance, Elsevier, vol. 66(C), pages 115-126.
    4. Chen, Son-Nan & Hsu, Pao-Peng, 2018. "Pricing and hedging barrier options under a Markov-modulated double exponential jump diffusion-CIR model," International Review of Economics & Finance, Elsevier, vol. 56(C), pages 330-346.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Shlomo Zilca, 2010. "The variance ratio and trend stationary model as extensions of a constrained autoregressive model," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 29(5), pages 467-475.
    2. Spierdijk, Laura & Bikker, Jacob A. & van den Hoek, Pieter, 2012. "Mean reversion in international stock markets: An empirical analysis of the 20th century," Journal of International Money and Finance, Elsevier, vol. 31(2), pages 228-249.
    3. Kim, Chang-Jin & Morley, James C. & Nelson, Charles R., 2001. "Does an intertemporal tradeoff between risk and return explain mean reversion in stock prices?," Journal of Empirical Finance, Elsevier, vol. 8(4), pages 403-426, September.
    4. John Okunev & Patrick J. Wilson, 1997. "Using Nonlinear Tests to Examine Integration Between Real Estate and Stock Markets," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 25(3), pages 487-503, September.
    5. Majumder, Debasish, 2013. "Towards an efficient stock market: Empirical evidence from the Indian market," Journal of Policy Modeling, Elsevier, vol. 35(4), pages 572-587.
    6. Nadiezhda de la Uz, 2002. "La hipótesis de martingala en el mercado bursátil mexicano," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 17(1), pages 91-127.
    7. Dichtl, Hubert & Drobetz, Wolfgang, 2011. "Portfolio insurance and prospect theory investors: Popularity and optimal design of capital protected financial products," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1683-1697, July.
    8. Campbell, John Y., 2001. "Why long horizons? A study of power against persistent alternatives," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 459-491, December.
    9. Giovanni Barone Adesi & Eckhard Platen & Carlo Sala, 2020. "On Using Equities to Produce Pension Payouts," Research Paper Series 413, Quantitative Finance Research Centre, University of Technology, Sydney.
    10. B M, Lithin & chakraborty, Suman & iyer, Vishwanathan & M N, Nikhil & ledwani, Sanket, 2022. "Modeling asymmetric sovereign bond yield volatility with univariate GARCH models: Evidence from India," MPRA Paper 117067, University Library of Munich, Germany, revised 05 Jan 2023.
    11. Björn Lutz, 2010. "Pricing of Derivatives on Mean-Reverting Assets," Lecture Notes in Economics and Mathematical Systems, Springer, number 978-3-642-02909-7, December.
    12. Wei-Chang Yeh & Yu-Hsin Hsieh & Chia-Ling Huang, 2022. "Newly Developed Flexible Grid Trading Model Combined ANN and SSO algorithm," Papers 2211.12839, arXiv.org.
    13. Tien Foo Sing & Kim Hiang Liow & Wei‐Jin Chan, 2002. "Mean reversion of Singapore property stock prices towards their fundamental values," Journal of Property Investment & Finance, Emerald Group Publishing Limited, vol. 20(4), pages 374-387, August.
    14. Jian Guo & Saizhuo Wang & Lionel M. Ni & Heung-Yeung Shum, 2022. "Quant 4.0: Engineering Quantitative Investment with Automated, Explainable and Knowledge-driven Artificial Intelligence," Papers 2301.04020, arXiv.org.
    15. Siddiqi, Hammad, 2013. "Analogy Making, Option Prices, and Implied Volatility," MPRA Paper 48862, University Library of Munich, Germany.
    16. Pat Wilson & John Okunev & Guy Ta, 1994. "Are Real Estate and Securities Markets Integrated? Some Australian Evidence," Working Paper Series 42, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
    17. Laurini, M. P. & Portugal, M. S., 2003. "Markov Switching Based Nonlinear Tests for Market Efficiency Using the R$/US$ Exchange Rate," Finance Lab Working Papers flwp_51, Finance Lab, Insper Instituto de Ensino e Pesquisa.
    18. Christoffersen, Peter & Jacobs, Kris & Ornthanalai, Chayawat & Wang, Yintian, 2008. "Option valuation with long-run and short-run volatility components," Journal of Financial Economics, Elsevier, vol. 90(3), pages 272-297, December.
    19. Perron, Pierre & Chun, Sungju & Vodounou, Cosme, 2013. "Sampling interval and estimated betas: Implications for the presence of transitory components in stock prices," Journal of Empirical Finance, Elsevier, vol. 20(C), pages 42-62.
    20. Liu, Chao-Shin & Ziebart, David A., 1999. "Anomalous security price behavior following management earnings forecasts," Journal of Empirical Finance, Elsevier, vol. 6(4), pages 405-429, October.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:reveco:v:18:y:2009:i:2:p:306-317. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620165 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.