Modeling regime transition in stock index futures markets and forecasting implications

Modeling regime transition in stock index futures markets and forecasting implications

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Article ID: iaor200969437
Country: United Kingdom
Volume: 27
Issue: 8
Start Page Number: 649
End Page Number: 669
Publication Date: Dec 2008
Journal: Journal of Forecasting
Authors:
Keywords: investment, forecasting: applications
Abstract:

Using a time-varying regime-switching vector error correction approach, this paper seeks to address which factors explain the transition across regimes of the US and the UK stock index futures markets. The findings suggest that the basis exercises a significant effect in regime transition. The basis effect is driven by a dividend yield effect in the UK, and by a dividend yield effect and an interest rate effect in the USA. The volatility of the underlying index is another significant factor, which is consistent with the significance of the basis in conjunction with Chen et al. (1995). Furthermore, there is evidence of an international regime transition effect from the UK to the USA. In most cases, forecasts based on time-varying regime transition models are more accurate than forecasts based on models with constant transition probabilities.

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