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Between The Rock and a Hard Place: Regime Switching in the RelationshipBetween Short-Term Interest Rates and Equity Returns in the UK

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  • Olan T Henry

Abstract

We examine the relationship between short term interest rates and UK equity returns using a two regime Markov Switching EGARCH model. We find one high-return, low variance regime in which the conditional variance of equity returns responds persistently but symmetrically to equity return innovations. In the other, low-mean, highvariance, regime there is evidence that equity volatility responds asymmetrically and without persistence to shocks to equity returns. There is evidence of a regime dependent relationship between shorter maturity interest rate differentials and equity return volatility. Furthermore, there is evidence that events in the money markets influence the probability of transition across regimes

Suggested Citation

  • Olan T Henry, 2007. "Between The Rock and a Hard Place: Regime Switching in the RelationshipBetween Short-Term Interest Rates and Equity Returns in the UK," Department of Economics - Working Papers Series 1019, The University of Melbourne.
  • Handle: RePEc:mlb:wpaper:1019
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    File URL: http://fbe.unimelb.edu.au/__data/assets/pdf_file/0003/802866/1019.pdf
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    Keywords

    Regime switching; Time varying transition probabilities; Newsimpact surfaces; Asymmetric volatility; Interest Rate Spreads;

    JEL classification:

    • G0 - Financial Economics - - General
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling

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