Reconnecting the Markov Switching Model with Economic Fundamentals

Arbeitspapier

This paper seeks to investigate and remedy the apparent inability of Markov regime switching models to predict future states in the medium to long term. We show that projected time varying transition probability series in the model may be biased towards predicting regime switches with high probability in the short run, and as a consequence it is hard or impossible to obtain longer run inference. We propose a penalized maximum likelihood estimator where non-smoothness in the transition series has negative influence on the likelihood function, which is shown to remedy the short run bias. In an empirical investigation of U.S. real GDP, the penalized model works better in terms of forecasting future recessions as defined by the NBER business cycle dating.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Working Paper ; No. 2004:4

Classification and Topics

• Classification: Wirtschaft ; Estimation: General ; Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models ; Business Fluctuations; Cycles
• Subject: regime switching ; transition probability ; forecasting

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Erlandsson, Ulf
• Event: Veröffentlichung
• (who): Lund University, School of Economics and Management, Department of Economics
• (where): Lund
• (when): 2004

Further information

• Handle: http://hdl.handle.net/10419/259880
• Last update: 10.03.2025, 11:42 AM CET