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Wavelet Improvement in Turning Point Detection using a Hidden Markov Model

  • Li, Yushu

    ()

    (Department of Business and Management Science, Norwegian School of Economics)

  • Reese, Simon

    ()

    (Department of Economics, Lund University)

Registered author(s):

The Hidden Markov Model (HMM) has been widely used in regime classification and turning point detection for econometric series after the decisive paper by Hamilton (1989). The present paper will show that when using HMM to detect the turning point in cyclical series, the accuracy of the detection will be influenced when the data are exposed to high volatilities or combine multiple types of cycles that have different frequency bands. Moreover, outliers will be frequently misidentified as turning points. The present paper shows that these issues can be resolved by wavelet multi-resolution analysis based methods. By providing both frequency and time resolutions, the wavelet power spectrum can identify the process dynamics at various resolution levels. We apply a Monte Carlo experiment to show that the detection accuracy of HMMs is highly improved when combined with the wavelet approach. Further simulations demonstrate the excellent accuracy of this improved HMM method relative to another two change point detection algorithms. Two empirical examples illustrate how the wavelet method can be applied to improve turning point detection in practice.

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Paper provided by Lund University, Department of Economics in its series Working Papers with number 2012:14.

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Length: 24 pages
Date of creation: 21 May 2012
Date of revision: 05 Apr 2014
Publication status: Published as Li, Yushu and Simon Reese, 'Wavelet Improvement in Turning Point Detection using a Hidden Markov Model' in Computational Statistics , 2014, pages 1481-1496.
Handle: RePEc:hhs:lunewp:2012_014
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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  1. Arthur F. Burns & Wesley C. Mitchell, 1946. "Measuring Business Cycles," NBER Books, National Bureau of Economic Research, Inc, number burn46-1, October.
  2. Hamilton, James D & Perez-Quiros, Gabriel, 1996. "What Do the Leading Indicators Lead?," The Journal of Business, University of Chicago Press, vol. 69(1), pages 27-49, January.
  3. Aurea Grané & Helena Veiga, 2009. "Wavelet-based detection of outliers in volatility models," Statistics and Econometrics Working Papers ws090403, Universidad Carlos III, Departamento de Estadística y Econometría.
  4. 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.
  5. Benoit Bellone & David Saint-Martin, 2004. "Detecting Turning Points with Many Predictors through Hidden Markov Models," Econometrics 0407001, EconWPA.
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