A New Regime Switching Model with State–Varying Endogeneity

• Main Authors: Tingting Cheng, Jiti Gao, Yayi Yan
• Format: Article
• Language: English
• Published: KeAi Communications Co., Ltd. 2018-12-01
• Series: Journal of Management Science and Engineering
• Online Access: http://www.sciencedirect.com/science/article/pii/S2096232019300484

In this paper, we propose a state-varying endogenous regime switching model (the SERS model), which includes the endogenous regime switching model by Chang et al., the CCP model, as a special case. To estimate the unknown parameters in the SERS model, we propose a maximum likelihood estimation method. Monte Carlo simulation results show that in the absence of state-varying endogeneity, the SERS model and the CCP model perform similarly, while in the presence of state-varying endogeneity, the SERS model performs much better than the CCP model. Finally, we use the SERS model to analyze Chinese stock market returns, and our empirical results show that there exists strongly state-varying endogeneity in volatility switching for the Shanghai Composite Index returns. Moreover, the SERS model can indeed produce a much more realistic assessment for the regime switching process than the one obtained by the CCP model. Keywords: Regime switching models, Latent factor, State-varying endogeneity, Maximum likelihood estimation, Markov chain