Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
958258 | Journal of Economics and Business | 2006 | 39 Pages |
Abstract
We estimate a number of multivariate regime switching VAR models on a long monthly US data set for eight variables that include excess stock and bond returns, the real T-bill yield, predictors used in the finance literature (default spread and the dividend yield), and three macroeconomic variables (inflation, industrial production growth, and a measure of real money growth). Heteroskedasticity may be accounted for by making the covariance matrix a function of the regime. We find evidence of four regimes and of time-varying covariances. We show that the best in-sample fit is provided by a four state model in which the VAR(1) component fails to be regime-dependent. We interpret this as evidence that the dynamic linkages between financial markets and the macroeconomy have been stable over time. The four-state model can be helpful in forecasting applications and provides one-step ahead predicted Sharpe ratios.
Keywords
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Authors
Massimo Guidolin, Sadayuki Ono,