Chen, Runquan (2009) Regime switching in volatilities and correlation between stock and bond markets. Discussion paper, 640. Financial Markets Group, London School of Economics and Political Science, London, UK.
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This paper studies the correlation and volatilities of the bond and stock markets in a regime- switching bivariate GARCH model. We extend the univariate Markov-Switching GARCH of Haas, Mittnik and Paolella (2004) into a bivariate Markov-switching GARCH model with Conditional Constant Correlation (CCC) speci…cation within each regime, though the correlation may change across regimes. Our model allows separate state variable governing each of the three processes: bond volatility, stock volatility and bond-stock correlation. We find that a separate state variable for the correlation is needed while the two volatility processes could largely share a common state variable, especially for the 10-year bond paired with S&P500. The "low-to-high" switching in stock volatility is more likely to be associated with the "high-to-low" switching in correlation while the "low-to-high" switching in bond volatility is likely to be associated with the "low-to-high" switching in correlation. The bond-stock correlation is significantly lower when the stock market volatility is in the high regime, but higher when the bond volatility is in its high regime.
|Item Type:||Monograph (Discussion Paper)|
|Additional Information:||© 2009 The author|
|Uncontrolled Keywords:||Regime-Switching, GARCH, DCC, CCC, Bond-Stock Market Correlation|
|Library of Congress subject classification:||H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
|Sets:||Research centres and groups > Financial Markets Group (FMG)
Collections > Economists Online
|Date Deposited:||09 Sep 2010 13:42|
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