Regime Changes and Financial Markets

35 Pages Posted: 20 Jul 2011

See all articles by Andrew Ang

Andrew Ang

BlackRock, Inc

Allan Timmermann

UCSD ; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 4 versions of this paper

Date Written: July 2011

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

JEL Classification: G11, G12

Suggested Citation

Ang, Andrew and Timmermann, Allan, Regime Changes and Financial Markets (July 2011). CEPR Discussion Paper No. DP8480, Available at SSRN: https://ssrn.com/abstract=1890003

Andrew Ang (Contact Author)

BlackRock, Inc ( email )

55 East 52nd Street
New York City, NY 10055
United States

Allan Timmermann

UCSD ( email )

9500 Gilman Drive
La Jolla, CA 92093-0553
United States
858-534-0894 (Phone)

HOME PAGE: http://rady.ucsd.edu/people/faculty/timmermann/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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