Markov Switching in Exchange Rate Models: Will More Regimes Help?
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.
|Date of creation:||Dec 2016|
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