Scandinavian Working Papers in Economics
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Institute for Economies in Transition, Bank of Finland BOFIT Discussion Papers, Institute for Economies in Transition, Bank of Finland

No 15/2014:
The credibility of Hong Kong’s currency board system: Looking through the prism of MS-VAR models with time-varying transition probabilities

Boris Blagov () and Michael Funke ()

Abstract: This paper takes seriously the idea that the coefficients of a VAR and the variance of shocks may be time-varying and so employs a Markov regime-switching VAR model to describe and analyse the time-varying credibility of Hong Kong’s currency board system. The endogenously estimated discrete regime shifts are made dependent on macroeconomic fundamentals. This enables us to determine which changes in macroeconomic variables can trigger switches between the low and high credibility regimes. We carry out extensive testing to search for the most appropriate specification of the Markov regime-switching model. We find strong evidence of regime switching behaviour that portrays the timevarying nature of credibility in the historical data. Our own conditional volatility index provides anticipatory signals and amplifies the regime-switching transition probabilities.

Keywords: Markov regime-switching VAR; exchange rate regime credibility; Hong Kong; (follow links to similar papers)

JEL-Codes: C11; C32; F31; F41; (follow links to similar papers)

35 pages, August 25, 2014

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