A tale of two states: asymmetries in the UK small,value and momentum premiums

This article performs comparative analysis of the asymmetries in size, value and momentum premium and their macroeconomic determinants over the UK economic cycles, using Markov switching approach. We associate Markov switching regime 1 with economic upturn and regime 2 with economic downturn. We find clear evidence of cyclical variations in the three premiums, most notable being that in the size premium, which changes from positive in expansions to negative in recessions. Macroeconomic indicators prompting such cyclicality the most are variables that proxy credit market conditions, namely the interest rates, term structure and credit spread. Overall, macro factors tend to have more significant impact on the three premiums during economic downturns. The results are robust to the choice of information variable used in modelling transition probabilities of the two-stage Markov switching model. We show that exploiting cyclicality in premiums proves particularly profitable for portfolios featuring small cap stocks in recessions at a feasible level of transaction costs.     

Asymmetric effect of advertising on the Chinese stock market

In this paper, we investigate whether investor attention to advertising has an asymmetric effect on Chinese stock returns by using a multivariate Markov switching model with time-varying regime transition probabilities. Using the Chinese stock market as a setting, we obtain lagged conditional volatility from generalized autoregressive conditional heteroskedasticity (GARCH) for modelling the time-varying transition probabilities of the regime-switching process to capture changes in the market regime. Our evidence documents that the high advertising portfolio does earn higher abnormal return than the low advertising portfolio in low-volatility periods. In high-volatility periods, however, the abnormal return is insignificant when the firm increases advertising spending. Our results support the behavioural model argument that in high-volatility period, advertising information diffuses slowly due to cognitive dissonance. Thus, the effect of advertising on stock returns is asymmetric, and it shows statistical significance in low-volatility periods.     

MODELLING A REGIME‐SHIFTING BEVERIDGE CURVE

This paper offers new insights into Beveridge curve analysis by modelling the unemployment–vacancy rate relationship within a Markov regime‐switching environment in which the probabilities of curve‐shifting are determined endogenously by shift factors. Shift factors include structural factors such as labour market participation and net migration, while cyclical variables include GDP growth, the real rate of interest, and labour productivity. This approach enables us to estimate regime‐specific parameters and to assess the role played by these factors in influencing the transition probabilities of switching between regimes. Using New Zealand data, we show that increases in the participation rate have shifted the Beveridge curve inward, while increases in net migration have shifted the curve outward.     

Contagion, Monsoons, and Domestic Turmoil in Indonesia's Currency Crisis

The paper investigates whether Indonesia's recent currency crisis was due to domestic fundamentals, common external shocks ("monsoons"), or contagion from neighboring countries. Markov switching models attribute speculative pressure on Indonesia's currency to domestic political and financial factors and contagion from speculative pressures in Thailand and Korea. In particular, the results from a time-varying transition probability Markov switching model (which overcomes some drawbacks of previous methods) show that inclusion of exchange rate pressures from Thailand and Korea in the transition probabilities improves the conditional probabilities of crisis in Indonesia. The paper also finds evidence of contagion in the stock market.     

The asymmetric effects of oil shocks on output growth: A Markov–Switching analysis for the G-7 countries

Oil shocks are generally acknowledged to have important effects on both economic activity and macroeconomic policy. The aim of this paper is to investigate how oil price shocks affect the growth rate of output of a subset of developed countries by comparing alternative regime switching models. Different Markov–Switching (MS) regime autoregressive models are, therefore, specified and estimated. In a successive step, univariate MS models are extended in order to verify if the inclusion of asymmetric oil shocks as an exogenous variable improves the ability of each specification to identify the different phases of the business cycle for each country under scrutiny. Following the wide literature on this topic, seven different definitions of oil shocks which are able to describe oil price changes, asymmetric transformations of oil price changes, oil price volatility, and oil supply conditions are considered.     

Explaining the Transition between Exchange Rate Regimes*

This paper studies the transition between exchange rate regimes using a Markov chain model with time‐varying transition probabilities. The probabilities are parameterized as nonlinear functions of variables suggested by the currency crisis and optimal currency area literature. Results using annual data indicate that inflation and, to a lesser extent, output growth and trade openness help explain the exchange rate regime transition dynamics.     

Optimal monetary policy regime for oil producing developing economies: Implications for post-war Iraq

This paper theoretically investigates optimal monetary policy regime for oil producing developing countries. We analyze credibility and reputation of the Central Bank and macroeconomic dynamics under alternative monetary policy regimes. We construct a detailed and realistic model that can be used to analyze macroecomic structure and expectation dynamics of an oil producing open economy. We take into account the asymmetric information between the public and the central bank and theoretically investigate how this asymmetric information impacts the real economy and the credibility of the central bank. The simulation results indicate that central bank achieves higher credibility and lower inflation under dollarization and higher output levels under currency board regime. The model constructed in this paper has many policy implications for oil producing open economies. Using the implications of the model, we make monetary policy regime recommendations for post-war Iraq.     

Do macroeconomic variables have regime-dependent effects on stock return dynamics? Evidence from the Markov regime switching model

The predictability of stock return dynamics is a topic discussed most frequently in empirical studies; however, no unanimous conclusion has yet been reached due to the ignorance of structural changes in stock price dynamics. This study applies various regime switching GJR-GARCH models to analyze the effects of macroeconomic variables (interest rate, dividend yield, and default premium) on stock return movements (including conditional mean, conditional variance, and transition probabilities) in the U.S. stock market, so as to clearly compare the predictive validity of stable and volatile states, as well as compare the in-sample and out-of-sample portfolio performance of regime switching models. The empirical results show that macro factors can affect the stock return dynamics through two different channels, and that the magnitude of their influences on returns and volatility is not constant. The effects of the three economic variables on returns are not time-invariant, but are closely related to stock market fluctuations, and the strength of predictability in a volatile regime is far greater than that in a stable regime. It is found that interest rate and dividend yield seem to play an important role in predicting conditional variance, and out-of-sample performance is largely eroded when the effects of these two factors on volatility are ignored. In addition, the three macro factors do not play any role in predicting transition probabilities.     

Macroeconomic environment,country risk and stock market performance: Evidence for Brazil

The paper aims at providing empirical evidence about (i) the influence of macroeconomic variables and economic policies on country risk and (ii) the influence of macroeconomic variables and country risk on the main Brazilian index of the stock market (Ibovespa). The study analyzes the role that macroeconomic fundamentals plays, but also the role that the credibility of the regime of inflation targeting and the reputation of the central bank play in lessening country risk and in the improvement of the stock market performance. The empirical evidence was obtained through the application of ordinary least squares (OLS), generalized method of moments (GMM) and GMM systems. The results found suggest that monetary policy and public debt management, as well as credibility and reputation affect country risk and the performance of the Brazilian stock market.     

OPTIMAL FORECAST COMBINATION UNDER REGIME SWITCHING*

This article proposes a new forecast combination method that lets the combination weights be driven by regime switching in a latent state variable. An empirical application that combines forecasts from survey data and time series models finds that the proposed regime switching combination scheme performs well for a variety of macroeconomic variables. Monte Carlo simulations shed light on the type of data‐generating processes for which the proposed combination method can be expected to perform better than a range of alternative combination schemes. Finally, we show how time variations in the combination weights arise when the target variable and the predictors share a common factor structure driven by a hidden Markov process.     

On business cycle fluctuations in USA macroeconomic time series

This study employs eighteen USA macroeconomic time series variables to investigate possible existence of asymmetries in business cycle fluctuations in the series. Detection of asymmetric fluctuations in economic activity is important for policymakers since effective monetary policy relies on asymmetric business cycle fluctuations in all the series. The asymmetric deviations from the long-term growth trend in each of the series are modeled using regime switching models and artificial neural networks. The results based on nonlinear switching time series models reveal strong evidence of business cycle asymmetries in most of the series. The results based on in-sample approximations from artificial neural networks show statistically significant evidence of asymmetries in all the series. Similar results are obtained when jackknife out-of-sample approximations from artificial neural networks are used. Thus, the study results show statistically significant evidence of asymmetries in all the series which indicates that business cycle fluctuations in the series are asymmetric, thus alike. Therefore, the impact of monetary policy shocks on the output and the other macroeconomic variables can be anticipated using nonlinear models only. The results on asymmetric business cycle fluctuations in real GDP are in line with recent studies but in sharp contrast with Balke and Fomby (1994).     

Asymmetric effects of industrial production,money supply and exchange rate changes on stock returns in Turkey

The aim of this article is twofold: First, it examines the asymmetric effects of industrial production, money supply and RER on stock returns in Turkey by using the non-linear autoregressive distributed lag (NARDL) model over the periods of 1994:01–2017:05 and 2002:01–2017:05. Second, it tries to determine whether there is a change of these macroeconomic variables’ effects on stock returns after the 2001 financial crisis since after 2002 period represents a structural break from the past in terms of economic, political and macroeconomic policy approaches. The study finds that the effects of the changes in industrial production, money supply and RER on stock returns are asymmetric, and the asymmetries are larger after the 2002 subsample compared to the full sample period. The empirical results further suggest that tight monetary policies appear to retard the stock returns more than easy monetary policies that stimulate them.     

体制转换模型能预测货币危机吗?

本文以名义汇率月变化率为因变量 ,引入因变量一阶自回归过程对Abiad(2 0 0 3 )提出的变动概率体制转换模型进行了修改 ,以此为基础 ,采用改进后的模型对阿根廷等 1 2个国家或地区在 1 978年 1月至 2 0 0 2年 5月期间发生或可能发生的货币危机进行了研究。本文主要回答两个问题 :根据体制转换模型建立的货币危机预警系统是否具有更强的预警能力 ?它预测危机发生的时机是否更准确 ?研究表明 :变动概率体制转换模型能够较为准确地预测货币危机发生的可能性和发生的时点 ;但是 ,对于不同的国家或地区 ,模型的预警效果有高有低 ;总体而言 ,该模型的预警能力很强 ,预警时效性较强     

Testing Markov switching models

In this article, we propose a new test for Markov switching models. Unlike the tests in the existing literature (e.g. Hansen, 1992; Garcia, 1998; Cho and White, 2007), we focus on testing the null of two regimes, instead of one single regime, in a switching framework. To implement our test, we propose a Markov switching model with absorbing states and examine whether the absorption probabilities are close to the boundary of the parameter space. We exploit recent advances by Andrews (2001) and conduct inference in the proposed model.     

Evaluating currency crises: A Bayesian Markov switching approach

In this paper we examine the nature of a currency crisis. We do so by employing an out-of-sample forecasting exercise to analyse the Mexican crisis in 1994. Forecast evaluation was based on modern econometric techniques concerning the shape of forecaster’s loss function. We also extend the empirical framework suggested by Jeanne and Masson [Jeanne, O., Masson, P., 2000. Currency crises and Markov-switching regimes. Journal of International Economics 50, 327–350] to test for the hypothesis that the currency crisis was driven by sunspots. To this end we contribute to the existing literature by comparing Markov regime switching model with a time-varying transition probabilities with two alternative models. The first is a Markov regime switching model with constant transition probabilities. The second is a linear benchmark model. Empirical results show that the proxy for the probability of devaluation is an important factor explaining the nature of currency crisis. More concretely, when the expectation market pressure was used as a proxy of probability of devaluation, forecast evaluation supports the view that currency crisis was driven by market expectation unrelated to fundamentals. Alternatively, when interest rate differential is used as a proxy for probability of devaluation, currency crisis was due to predictable deterioration of fundamentals.     

Macroeconomic variables and the sovereign risk premia in EMU,non-EMU EU,and developed countries

This project studies and models key macroeconomic variables and their impact on sovereign risk premia across select European economies and developed countries. The sample is divided into three groups of countries: those in the European Monetary Union (EMU); the standalone economies outside the EMU but members of the broader European Union (EU); and other developed economies. The main subject of examination across all three groups is the impact of macroeconomic variables on sovereign borrowing costs. EU countries have experienced high financial stress and a rapid rise in the credit default swaps (CDS) spreads during the EMU debt crisis. A nonlinear vector smooth transition autoregressive model is applied to investigate such a regime change in the finance-output link using sovereign CDS and industrial production index. The paper finds that regime-switching takes place rather suddenly in most EMU countries. The study concludes that due to the potential spillover effects in the EU as a whole, the individual country macroeconomic indicators were less reflected in the financial stress and spillover and contagion effects became dominant.     

Does purchasing power parity hold sometimes? Regime switching in real exchange rates

Standard unit root tests are not very powerful in drawing conclusions regarding the validity of Purchasing Power Parity (PPP). Rather than asking whether PPP holds throughout the whole sample period, we examine, in this study, if PPP holds sometimes by employing Hamilton-type (1989) Markov regime switching models. When at least one of multiple regimes is stationary, PPP holds locally within the regime. There are indeed various reasons that we should expect that the persistence of real exchange rates changes over time. Employing five real exchange rates spanning more than 100 years, we find herein strong evidence that the strength of PPP varies during the sample periods and that there exist stationary regimes in which PPP holds. Throughout the article, we also make comparisons to previous Markov regime switching estimation results by Kanas (2006) on the same data series. The new Markov switching model selection criterion of Smith et al. (2006), which is devised especially for discriminating Markov regime switching models, unambiguously indicates a preference for the Hamilton-type Markov regime switching model employed in this study. We also find that the evidence for PPP is not much different across different nominal exchange rate arrangements.     

Assessing fiscal sustainability subject to policy changes: a Markov switching cointegration approach

We propose a Markov switching cointegration approach to assess long run fiscal sustainability. This method allows us to simultaneously: (1) test for cointegration in the presence of significant fiscal policy changes; (2) assess the type of fiscal regime that a country experienced at a given period and (3) analyse the timing of the transition between the estimated regime types. Given its flexibility, our approach enable us to uncover a richer and more complex dynamics in the analysis of fiscal sustainability, which standard linear cointegration methods fail to capture.     

Interest Rate Volatility Regimes in Selected Asian Countries:A Univariate Markov Switching Analysis

Business cycle dynamics are determined by relatively large volatilities in output,consumption,and investment,which leads to cyclical fluctuations in interest rates.Using the Markov switching model,we model the nominal interest rate movements to explain the volatility regime shifts in a set of selected emerging Asian economies.The estimated results provide significant evidence of regime-dependent means,variances,and probabilities in both stable and volatile regimes in selected countries,confirming the existence of two distinct regimes in nominal interest rate movements.In addition,the smoothed probability results of switching autoregressive model show that the model is capable of capturing the two regimes for the corresponding nominal interest rate behaviors.Besides,the results reveal that the stables regimes have higher durations than the volatile regimes.This study also shows the advantage of Markov switching models over conventional regression models,allowing the identification of different regimes for the cyclical behavior of interest rates.     

Forecasting macro variables with a Qual VAR business cycle turning point index

One criticism of Vector Autoregression (VAR) forecasting is that macroeconomic variables tend not to behave as linear functions of their own past around business cycle turning points. A large amount of literature therefore focuses on nonlinear forecasting models, such as Markov switching models, which only indirectly capture the relation with turning points. This article investigates a direct approach to using information on turning points from the National Bureau of Economic Research (NBER) chronology to model and forecast macroeconomic data. Our Qual VAR model includes a truncated normal latent business cycle index that is negative during NBER recessions and positive during expansions. We motivate our forecasting exercise by demonstrating that if starting from a linear specification, a truncated normal variable is an omitted variable, then forecasts of the remaining variables will become nonlinear functions of their own past. We apply the Qual VAR model to recursive out-of-sample forecasting and find that the Qual VAR improves on out-of-sample forecasts from a standard VAR.