Steen Nielsen and Jan Overgaard Olesen
Steen Nielsen: Department of Economics, Copenhagen Business School, Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark
Jan Overgaard Olesen: Department of Economics, Copenhagen Business School, Postal: Department of Economics, Copenhagen Business School, Solbjerg Plads 3 C, 5. sal, DK-2000 Frederiksberg, Denmark
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.
31 pages, July 12, 2001
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