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Regime switching in the present value models: A backward-solving method

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  • Kim, Jan R.
  • Chung, Keunsuk

Abstract

We develop a new method for incorporating regime shifts in the present value models. Existing studies solve the present value problem forward by projecting the expectations of investors and regimes into the infinite future. Representing the problem in a recursive form, we propose a backward-solving approach in which the initially guessed formulation of the present value is verified by the undetermined coefficients method. Unlike the forward-solving methods, ours does not resort to unnecessary approximations or overly restricted forms of regime switching. Applied to the Korean housing market, our regime-switching present value model sharply detects two distinctive regimes in the behaviour of the price-rent ratio.

Suggested Citation

  • Kim, Jan R. & Chung, Keunsuk, 2020. "Regime switching in the present value models: A backward-solving method," Finance Research Letters, Elsevier, vol. 32(C).
    • Handle: RePEc:eee:finlet:v:32:y:2020:i:c:s154461231830881x
    DOI: 10.1016/j.frl.2019.02.001
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    More about this item

    Keywords

    Regime switching; Present value model; Recursive form; Backward solving; Undetermined coefficients;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • G1 - Financial Economics - - General Financial Markets
    • R3 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location

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