A multivariate regime-switching GARCH model with an application to global stock market and real estate equity returns

Abstract

Abstract:We consider a multivariate Markov-switching GARCH model which allows for regime-specific volatility dynamics, leverage effects, and correlation structures. Conditions for stationarity and expressions for the moments of the process are derived. A Lagrange Multiplier test against misspecification of the within-regime correlation dynamics is proposed, and a simple recursion for multi-step-ahead conditional covariance matrices is deduced. We use this methodology to model the dynamics of the joint distribution of global stock market and real estate equity returns. The empirical analysis highlights the importance of the conditional distribution in Markovswitching time series models. Specifications with Student's t innovations dominate their Gaussian counterparts both in-and out-of-sample. The dominating specification appears to be a two-regime Student's t process with correlations which are higher in the turbulent (high-volatility) regime.

Asset allocation and regime switching on Croatian financial market

“…Nomikos, Alizadeh and Pouliasis [27] showed that RS BEKK was suitable for futures markets (based on USA data). A significant contribution was provided by Haas and Mittnik [19]. They thoroughly defined a multivariate generalization of the RS GARCH model (diagonal VEC model).…”

“…In the following year, Chen [12] focused on the CCC model. He elaborated that in the model in [19], it was difficult to estimate the correlations. The reason for this is that when a correlation changes, the degree of change in the variance of one return or the other affecting the correlation is unknown.…”

“…In the last couple of years, several papers have emerged focusing on specific markets. Some studies include Sheu and Lee [31], Otranto [28], Haas and Liu [18], Sheu, Lee and Lai [32], etc. Such research emphasizes the importance of incorporating the RS methodology when modeling risk and return on financial markets.…”

The place of gold in the cross-market dependencies

“…Therefore, our contribution is to examine the interactions between Gold and alternative classes of assets, not only in a time-varying fashion using a bivariate GARCH (with return and volatility spillovers), but also enabling these interactions to evolve depending on the regime under consideration. More precisely, this paper implements a BEKK model with Markov-switching -the MS-BEKK by Haas and Mittnik (2008) -on Gold, S&P 500, Bonds, Crude Oil, Silver, Platinum and Palladium, from 1988to 2013 In this modeling framework, Haas, Mittnik, and Paolella (2004), Kasch and Caporin (2013) provide recent applications to, respectively, exchange rate and equity dynamics in order to study cross-market dependencies conditional on volatility regimes.…”

“…stocks, bonds, crude oil) on the other hand. The econometric methodology relies on the Markov-switching BEKK model by Haas and Mittnik (2008) that captures time-varying correlations and bull-bear regimes for bivariate specifications. The model is applied to daily data from 1988 to 2013.…”