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An econometric model of nonlinear dynamics in the joint distribution of stock and bond returns

  • Massimo Guidolin
  • Allan Timmerman

This paper considers a variety of econometric models for the joint distribution of US stock and bond returns in the presence of regime switching dynamics. While simple two- or three-state models capture the univariate dynamics in bond and stock returns, a more complicated four state model with regimes characterized as crash, slow growth, bull and recovery states is required to capture their joint distribution. The transition probability matrix of this model has a very particular form. Exits from the crash state are almost always to the recovery state and occur with close to 50 percent chance suggesting a bounce-back effect from the crash to the recovery state.

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File URL: http://research.stlouisfed.org/wp/2005/2005-003.pdf
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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2005-003.

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Date of creation: 2005
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Publication status: Published in Journal of Applied Econometrics, January 2006, 21(1), pp. 1-22
Handle: RePEc:fip:fedlwp:2005-003
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  1. Christopher M. Turner & Richard Startz & Charles R. Nelson, 1989. "A Markov Model of Heteroskedasticity, Risk, and Learning in the Stock Market," NBER Working Papers 2818, National Bureau of Economic Research, Inc.
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  8. Christina D. Romer and David H. Romer., 1989. "Does Monetary Policy Matter? A New Test in the Spirit of Friedman and Schwartz," Economics Working Papers 89-107, University of California at Berkeley.
  9. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
  10. Robert B. Davies, 2002. "Hypothesis testing when a nuisance parameter is present only under the alternative: Linear model case," Biometrika, Biometrika Trust, vol. 89(2), pages 484-489, June.
  11. Simon van Norden & Huntley Schaller & ), 1995. "Regime Switching in Stock Market Returns," Econometrics 9502002, EconWPA.
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  14. 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.
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