Regime Switching in Stock Market Returns

Simon van Norden (), Huntley Schaller and )

Econometrics from EconWPA

Abstract: In this paper, we use an extension of Hamilton's (1989) Markov switching techniques to describe and analyze stock market returns. Using new tests, we find very strong evidence of switching behaviour. A major innovation of our work is to use a multivariate specification which allows us to examine whether the price-dividend ratio has marginal predictive power for stock market returns after accounting for state-dependent switching. We find strong evidence of predictability. The response of returns to the past price-dividend ratio is strongly asymmetric - about four times larger in the low-return state than in the high-return state. A second innovation in our work is to allow the probability of transitions from one regime to another to depend on economic variables.

JEL-codes: C1 C2 C3 C4 C5 C8 (search for similar items in EconPapers)
Date: 1995-02-07
Note: 41 pages of text & 6 pages graphs. Text and Graphs in separate Postscript files. Both files compressed in a single Info-zip archive, then uuencoded.
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Related works:
Journal Article: Regime Switching in Stock Market Returns (1997)
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpem:9502002

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