Working Paper Series, Department of Economics, Copenhagen Business School
No 11-2000:
REGIME-SWITCHING STOCK RETURNS AND MEAN REVERSION
Steen Nielsen and Jan Overgaard Olesen
Abstract: We estimate a well-specified two-state regime-switching
model for Danish stock returns. The
model identifies two regimes which
have low return-low volatility and high return-high
volatility,
respectively. The low return-low volatility regime dominated, except in a
few, short
episodes, until the beginning of the 70s whereas the 80s and
90s have been characterized by
high return and high volatility. We
propose an alternative test of mean reversion which allows
for multiple
regimes with potentially different constant and autoregressive terms and
different
volatility. Using this test procedure we find mean reversion
at 10% but not at 5% significance
level which is weaker evidence than
produced by estimating a standard autoregressive model
for returns.
Furthermore, when analyzing contributions of the two regimes we find that
the
indication of mean reversion is due to the recent high return-high
volatility regime only.
Keywords: Regime-Switching; Stock returns; Mean reversion; Denmark; (follow links to similar papers)
JEL-Codes: G19; (follow links to similar papers)
31 pages, July 12, 2001
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