The Regime Switching Model and Financial Market Crises
Economic and financial time series models show periodic changes in parameters. The aim of this paper is to describe the evolution of financial markets examining assets portfolios in a regime change model and to determine the impact of these changes on the choice of international portfolios. Applying the Markov model to study crises reveals the dynamic properties of equity series and currency exchange rates and highlights the potential for transition from one regime to another over time. Long-term forecasts of excess returns for both models then depend on transition probabilities. The study of the volatilities of the various markets shows an upward trend in in regime 1 and a return process to the average in regime 2. Correlation is strongly sensitive to market uncertainty. When market volatility increases, the correlation between these markets increases and vice versa, generating a contagion effect.
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