Regime Changes and Financial Markets

Allan Timmermann and Andrew Ang

No 8480, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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. While 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 regime switching means, volatilities, autocorrelations, and cross-covariances of asset returns often differ across regimes, which allow 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, like consumption or dividend growth, strongly affect the dynamic properties of equilibrium asset prices and can induce non-linear risk-return trade-offs. Regime switches also lead to potentially large consequences for investors' optimal portfolio choice.

Keywords: Jumps; Mixture distributions; Non-linear equilibrium asset pricing models; Rare events; Regime switching (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2011-07
New Economics Papers: this item is included in nep-cba
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Citations: View citations in EconPapers (51)

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Related works:
Journal Article: Regime Changes and Financial Markets (2012)
Working Paper: Regime Changes and Financial Markets (2011)
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