Regime Changes and Financial Markets

Andrew Ang and Allan Timmermann ()
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Allan Timmermann: Rady School of Management and Department of Economics, University of California, San Diego, La Jolla, California 92093

Annual Review of Financial Economics, 2012, vol. 4, issue 1, 313-337

Abstract: Regime-switching models can match the tendency of financial markets to often change their behavior abruptly and the phenomenon that the new behavior of financial variables often persists for several periods after such a change. Although the regimes captured by regime-switching models are identified by an econometric procedure, they often correspond to different periods in regulation, policy, and other secular changes. In empirical estimates, the means, volatilities, autocorrelations, and cross-covariances of asset returns often differ across regimes in a manner that allows regime-switching models to capture the stylized behavior of many financial series including fat tails, heteroskedasticity, skewness, and time-varying correlations. In equilibrium models, regimes in fundamental processes, such as consumption or dividend growth, strongly affect the dynamic properties of equilibrium asset prices and can induce nonlinear risk-return trade-offs. Regime switches also lead to potentially large consequences for investors' optimal portfolio choice.

Keywords: regime switching; nonlinear equilibrium asset pricing models; mixture distributions; rare events; jumps (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (151)

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Related works:
Working Paper: Regime Changes and Financial Markets (2011)
Working Paper: Regime Changes and Financial Markets (2011)
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