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A State Dependent Regime Switching Model of Dynamic Correlations

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  • Tejeda, Hernan A.
  • Goodwin, Barry K.
  • Pelletier, Denis

Abstract

We extend the Regime Switching for Dynamic Correlations (RSDC) model by Pelletier (Journal of Econometrics, 2006), to determine the effect of underlying fundamental variables in the evolution of the dynamic correlations between multiple time series. By introducing state dependent transition probabilities to the switching process between different regimes - governed by a Markov chain, we are able to identify potential thresholds and spillover effects in the dynamic process. In addition, asymmetric correlations between the series are determined. We simulate data for multiple series and find an initial better fit of state dependent transition probabilities, versus constant transition probabilities, for the regime switching model. Capturing more precisely the dynamic interrelationships between multiple series or markets conveys many benefits including - potential efficiency gains from related operations, determining the effects of shocks from related variables, as well as improvement in hedging operations.

Suggested Citation

  • Tejeda, Hernan A. & Goodwin, Barry K. & Pelletier, Denis, 2009. "A State Dependent Regime Switching Model of Dynamic Correlations," 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin 49370, Agricultural and Applied Economics Association.
    • Handle: RePEc:ags:aaea09:49370
    DOI: 10.22004/ag.econ.49370
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    Cited by:

    1. Hernan A. Tejeda & Barry K. Goodwin, 2014. "Dynamic multiproduct optimal hedging in the soybean complex - do time-varying correlations provide hedging improvements?," Applied Economics, Taylor & Francis Journals, vol. 46(27), pages 3312-3322, September.
    2. Xiaodong Du and Lihong Lu McPhail, 2012. "Inside the Black Box: the Price Linkage and Transmission between Energy and Agricultural Markets," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    3. Ojea-Ferreiro, Javier & Reboredo, Juan C., 2022. "Exchange rates and the global transmission of equity market shocks," Economic Modelling, Elsevier, vol. 114(C).
    4. Tejeda, Hernan A. & Goodwin, Barry K., 2009. "Price Volatility, Nonlinearity, and Asymmetric Adjustments in Corn, Soybean, and Cattle Markets: Implications of Ethanol-Driven (Market) Shocks," 2009 Conference, April 20-21, 2009, St. Louis, Missouri 53039, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.

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