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A new approach to markov-switching GARCH models


Paolella, Marc; Haas, Markus; Mittnik, Stefan (2004). A new approach to markov-switching GARCH models. Journal of Financial Econometrics, 2(4):493-530.

Abstract

The use of Markov-switching models to capture the volatility dynamics of financial time series has grown considerably during past years, in part because they give rise to a plausible interpretation of nonlinearities. Nevertheless, GARCH-type models remain ubiquitous in order to allow for nonlinearities associated with time-varying volatility. Existing methods of combining the two approaches are unsatisfactory, as they either suffer from severe estimation difficulties or else their dynamic properties are not well understood. In this article we present a new Markov-switching GARCH model that overcomes both of these problems. Dynamic properties are derived and their implications for the volatility process discussed. We argue that the disaggregation of the variance process offered by the new model is more plausible than in the existing variants. The approach is illustrated with several exchange rate return series. The results suggest that a promising volatility model is an independent switching GARCH process with a possibly skewed conditional mixture density

Abstract

The use of Markov-switching models to capture the volatility dynamics of financial time series has grown considerably during past years, in part because they give rise to a plausible interpretation of nonlinearities. Nevertheless, GARCH-type models remain ubiquitous in order to allow for nonlinearities associated with time-varying volatility. Existing methods of combining the two approaches are unsatisfactory, as they either suffer from severe estimation difficulties or else their dynamic properties are not well understood. In this article we present a new Markov-switching GARCH model that overcomes both of these problems. Dynamic properties are derived and their implications for the volatility process discussed. We argue that the disaggregation of the variance process offered by the new model is more plausible than in the existing variants. The approach is illustrated with several exchange rate return series. The results suggest that a promising volatility model is an independent switching GARCH process with a possibly skewed conditional mixture density

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Scope:Contributions to practice (applied research)
Language:English
Date:2004
Deposited On:30 Jul 2014 12:41
Last Modified:06 Mar 2024 14:06
Publisher:Oxford University Press
ISSN:1479-8409
OA Status:Closed
Publisher DOI:https://doi.org/10.1093/jjfinec/nbh020
Official URL:http://jfec.oxfordjournals.org/content/2/4/493.short
Other Identification Number:merlin-id:4472
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