REGIME-SWITCHING STOCK RETURNS AND MEAN REVERSION

Steen Nielsen and Jan Overgaard Olesen
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Steen Nielsen: Department of Economics, Copenhagen Business School, Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark
Jan Overgaard Olesen: Department of Economics, Copenhagen Business School, Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark

No 11-2000, Working Papers from Copenhagen Business School, Department of Economics

Abstract: We estimate a well-specified two-state regime-switching model for Danish stock returns. The

model identifies two regimes which have low return-low volatility and high return-high

volatility, respectively. The low return-low volatility regime dominated, except in a few, short

episodes, until the beginning of the 70s whereas the 80s and 90s have been characterized by

high return and high volatility. We propose an alternative test of mean reversion which allows

for multiple regimes with potentially different constant and autoregressive terms and different

volatility. Using this test procedure we find mean reversion at 10% but not at 5% significance

level which is weaker evidence than produced by estimating a standard autoregressive model

for returns. Furthermore, when analyzing contributions of the two regimes we find that the

indication of mean reversion is due to the recent high return-high volatility regime only.

Keywords: Regime-Switching; Stock returns; Mean reversion; Denmark (search for similar items in EconPapers)
JEL-codes: G19 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2001-07-12
New Economics Papers: this item is included in nep-ets and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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