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Choosing information variables for transition probabilities in a time-varying transition probability Markov switching model

  • Andrew J. Filardo

This paper discusses a practical estimation issue for time-varying transition probability (TVTP) Markov switching models. Time-varying transition probabilities allow researchers to capture important economic behavior that may be missed using constant (or fixed) transition probabilities. Despite its use, Hamilton’s (1989) filtering method for estimating fixed transition probability Markov switching models may not apply to TVTP models. This paper provides a set of sufficient conditions to justify the use of Hamilton’s method for TVTP models. In general, the information variables that govern time-variation in the transition probabilities must be conditionally uncorrelated with the state of the Markov process.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number 98-09.

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Date of creation: 1998
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Handle: RePEc:fip:fedkrw:98-09
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  1. 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.
  2. Kim, C-J., 1991. "Dynamic Linear Models with Markov-Switching," Papers 91-8, York (Canada) - Department of Economics.
  3. Simon van Norden & Huntley Schaller & ), 1995. "Regime Switching in Stock Market Returns," Econometrics 9502002, EconWPA.
  4. Kiefer, Nicholas M, 1978. "Discrete Parameter Variation: Efficient Estimation of a Switching Regression Model," Econometrica, Econometric Society, vol. 46(2), pages 427-34, March.
  5. Gray, Stephen F., 1996. "Modeling the conditional distribution of interest rates as a regime-switching process," Journal of Financial Economics, Elsevier, vol. 42(1), pages 27-62, September.
  6. Filardo, Andrew J. & Gordon, Stephen F., 1998. "Business cycle durations," Journal of Econometrics, Elsevier, vol. 85(1), pages 99-123, July.
  7. Charles Engel & Craig S. Hakkio, 1994. "The distribution of exchange rates in the EMS," Research Working Paper 94-03, Federal Reserve Bank of Kansas City.
  8. Filardo, Andrew J, 1994. "Business-Cycle Phases and Their Transitional Dynamics," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 299-308, July.
  9. Cosslett, Stephen R. & Lee, Lung-Fei, 1985. "Serial correlation in latent discrete variable models," Journal of Econometrics, Elsevier, vol. 27(1), pages 79-97, January.
  10. Francis X. Diebold & Joon-Haeng Lee & Gretchen C. Weinbach, 1993. "Regime switching with time-varying transition probabilities," Working Papers 93-12, Federal Reserve Bank of Philadelphia.
  11. Hamilton, James D., 1986. "State-space models," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 50, pages 3039-3080 Elsevier.
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