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Markov Switching in Exchange Rate Models: Will More Regimes Help?

Listed author(s):
  • Josh Stillwagon
  • Peter Sullivan

    ()

    (Department of Economics, Trinity College)

This paper examines the performance of Markov switching models (MSM) of the exchange rate using a data driven approach to determine the number of regimes. The analysis is conducted for the British pound/USD over the last thirty years with alternative specifications from the literature. A noteworthy finding is that there is a close correspondence among the number of regimes that minimizes mean square forecast errors, the number of regimes selected by traditional information criteria (but not Markov switching specific information criteria), and the fewest regimes with well-behaved residuals. Although allowing for more regimes yields improvement over single or two regime models, the MSM is still unable to outperform a random walk.

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File URL: http://internet2.trincoll.edu/repec/WorkingPapers2016/WP16-02.pdf
File Function: First version, 2016
Download Restriction: no

Paper provided by Trinity College, Department of Economics in its series Working Papers with number 1602.

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Length: 32 pages
Date of creation: Dec 2016
Handle: RePEc:tri:wpaper:1602
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Web page: http://www.trincoll.edu/Academics/MajorsAndMinors/Economics/Pages/default.aspx

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