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Combining Markov Switching and Smooth Transition in Modeling Volatility: A Fuzzy Regime MEM

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Abstract

Volatility in financial markets alternates persistent turmoil and quiet periods. Modelling realized volatility time series requires a specification in which these sub-periods are adequately represented. Changes in regimes is a solution, but the question of whether transition between periods is abrupt or smooth remains open. We provide a new class of models with a set of parameters subject to abrupt changes in regime and another set subject to smooth transition changes. These models capture the possibility that regimes may overlap with one another ( fuzzy ). The empirical application is carried out on the volatility of four US indices.

Suggested Citation

  • Giampiero M. Gallo & Edoardo Otranto, 2016. "Combining Markov Switching and Smooth Transition in Modeling Volatility: A Fuzzy Regime MEM," Econometrics Working Papers Archive 2016_02, Universita' degli Studi di Firenze, Dipartimento di Statistica, Informatica, Applicazioni "G. Parenti".
    • Handle: RePEc:fir:econom:wp2016_02
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    References listed on IDEAS

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    More about this item

    Keywords

    Volatility; Regime switching; Smooth transition; Forecasting; Turbulence; Multiplicative Error Models; MEM;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G01 - Financial Economics - - General - - - Financial Crises

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