Reconnecting the Markov Switching Model with Economic Fundamentals
This paper seeks to investigate and remedy the apparent inability of Markov regime switching models to predict future states in the medium to long term. We show that projected time varying transition probability series in the model may be biased towards predicting regime switches with high probability in the short run, and as a consequence it is hard or impossible to obtain longer run inference. We propose a penalized maximum likelihood estimator where non-smoothness in the transition series has negative influence on the likelihood function, which is shown to remedy the short run bias. In an empirical investigation of U.S. real GDP, the penalized model works better in terms of forecasting future recessions as defined by the NBER business cycle dating.
|Date of creation:||27 Jan 2004|
|Date of revision:||18 Mar 2004|
|Contact details of provider:|| Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden|
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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- Filardo, Andrew J. & Gordon, Stephen F., 1998.
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- Cheung, Yin-Wong & Erlandsson, Ulf G., 2005. "Exchange Rates and Markov Switching Dynamics," Journal of Business & Economic Statistics, American Statistical Association, vol. 23, pages 314-320, July.
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- Yin-wong Cheung & Ulf G. Erlandsson, 2005. "Exchange Rates and Markov Switching Dynamics," Working Papers 052005, Hong Kong Institute for Monetary Research.
- 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 357-384, March.
- Abdul d Abiad, 2003. "Early Warning Systems; A Survey and a Regime-Switching Approach," IMF Working Papers 03/32, International Monetary Fund. Full references (including those not matched with items on IDEAS)
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