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Time‐Varying Transition Probabilities for Markov Regime Switching Models
Author(s) -
Bazzi Marco,
Blasques Francisco,
Koopman Siem Jan,
Lucas Andre
Publication year - 2017
Publication title -
journal of time series analysis
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.576
H-Index - 54
eISSN - 1467-9892
pISSN - 0143-9782
DOI - 10.1111/jtsa.12211
Subject(s) - mathematics , variance (accounting) , markov chain , monte carlo method , novelty , range (aeronautics) , statistical physics , econometrics , markov model , markov chain monte carlo , statistics , engineering , philosophy , physics , accounting , theology , business , aerospace engineering
We propose a new Markov switching model with time‐varying transitions probabilities. The novelty of our model is that the transition probabilities evolve over time by means of an observation driven model. The innovation of the time‐varying probability is generated by the score of the predictive likelihood function. We show how the model dynamics can be readily interpreted. We investigate the performance of the model in a Monte Carlo study and show that the model is successful in estimating a range of different dynamic patterns for unobserved regime switching probabilities. We also illustrate the new methodology in an empirical setting by studying the dynamic mean and variance behaviour of US industrial production growth.