Optimal investment with time-varying transition probabilities for regime switching

2021 ◽  
Vol 29 (2) ◽  
pp. 102-115
Author(s):  
Hyo-Chan Lee ◽  
Seyoung Park ◽  
Jong Mun Yoon
Keyword(s):  
Regime Switching ◽  
Transition Probabilities ◽  
Optimal Investment ◽  
Cash Flows ◽  
Optimal Timing ◽  
Time Varying ◽  
Content Type ◽  
Stochastic Nature ◽  
Optimal Thresholds

Abstract This study aims to generalize the following result of McDonald and Siegel (1986) on optimal investment: it is optimal for an investor to invest when project cash flows exceed a certain threshold. This study presents other results that refine or extend this one by integrating timing flexibility and changes in cash flows with time-varying transition probabilities for regime switching. This study emphasizes that optimal thresholds are either overvalued or undervalued in the absence of time-varying transition probabilities. Accordingly, the stochastic nature of transition probabilities has important implications to the search for optimal timing of investment.

The impact of global financial market uncertainty on the risk-return relation in the stock markets of G7 countries

2017 ◽  
Vol 34 (1) ◽  
pp. 2-23 ◽  
Author(s):  
Geoffrey Loudon
Keyword(s):  
Financial Market ◽  
Stock Markets ◽  
Regime Switching ◽  
Transition Probabilities ◽  
Market Uncertainty ◽  
Content Type ◽  
Regime Switching Model ◽  
Switching Model ◽  
Risk Return ◽  
The Impact

Purpose This paper aims to investigate the effect of global financial market uncertainty on the relation between risk and return in G7 stock markets. Design/methodology/approach Market uncertainty is quantified using a probability-based measure derived from a regime-switching model in which the state transition probabilities are time-varying in response to leading economic indicators. Time variation in the risk return relation is estimated using a GARCH-M model. Findings While the regime-switching model successfully distinguishes between crisis and normal states, there remains substantial variability through time in the level of uncertainty about which state prevails. Results show that a strong negative relation exists between this uncertainty and the reward-to-variability ratio across all G7 stock markets. This finding is qualitatively consistent at both monthly and weekly horizons. Originality/value Extant evidence on the risk-return relation is conflicting. Most papers assume the relation is time constant. Allowing the reward-to-variability ratio to vary through time in response to return regime uncertainty increases the understanding of asset pricing. It also has important implications for asset allocation decisions by investors.

7. Regime Switching with Time-Varying Transition Probabilities

1999 ◽  
pp. 144-166 ◽  
Author(s):  
Francis Diebold ◽  
Joon Lee ◽  
Gretchen Weinbach
Keyword(s):  
Regime Switching ◽  
Transition Probabilities ◽  
Time Varying

scholarly journals Time-Varying Transition Probabilities for Markov Regime Switching Models

2016 ◽  
Vol 38 (3) ◽  
pp. 458-478 ◽  
Author(s):  
Marco Bazzi ◽  
Francisco Blasques ◽  
Siem Jan Koopman ◽  
Andre Lucas
Keyword(s):  
Regime Switching ◽  
Transition Probabilities ◽  
Time Varying ◽  
Markov Regime Switching ◽  
Regime Switching Models ◽  
Switching Models

The impact of market coupling on Hungarian and Romanian electricity markets: Evidence from the regime-switching model

2017 ◽  
Vol 28 (5-6) ◽  
pp. 621-638 ◽  
Author(s):  
Vika Koban
Keyword(s):  
Wind Power ◽  
Regime Switching ◽  
Transition Probabilities ◽  
Power Production ◽  
Time Varying ◽  
Electricity Prices ◽  
Regime Switching Model ◽  
Switching Model ◽  
The Impact ◽  
Market Coupling

This paper investigates the impact of market coupling on (1) electricity prices of Hungarian and Romanian markets and (2) the influence of renewable generation on price regimes by employing the Markov regime-switching model with time-varying transition probabilities. The study provides the evidence of the changes in regimes since market coupling. The results show that the persistence and occurrences of Hungarian price drops are significantly increased. Meanwhile, Romanian prices exhibit less and shorter living price jumps. Considering time-varying transition probabilities as functions of wind power production in Romania, the study also reveals that market coupling changed the influence of wind power production on the regime-switching mechanism of electricity prices.

scholarly journals A Markov Regime-Switching Model with Time-Varying Transition Probabilities for Identifying Asset Price Bubbles

2018 ◽  
Vol 10 (4) ◽  
pp. 1 ◽  
Author(s):  
Matthew L. Higgins ◽  
Frank Ofori-Acheampong
Keyword(s):  
Regime Switching ◽  
Transition Probabilities ◽  
Asset Price ◽  
Time Varying ◽  
Markov Regime Switching ◽  
Regime Switching Model ◽  
Switching Model ◽  
Asset Price Bubbles ◽  
Price Bubbles ◽  
Markov Regime Switching Model

In this paper, a Markov regime-switching model with time-varying transition probabilities is developed to identify asset price bubbles in the S&P 500 index. The model nests two different methodologies; a state-dependent regime-switching model and a Markov regime-switching model. Three bubble regimes are identified; dormant, explosive, and collapsing. Time-varying transition probabilities are specified for each of the nine possible transitions in the Markov regime-switching model. Estimation of the model is done using conditional maximum likelihood with the Hamilton filter. Results show that transition probabilities depend significantly on trading volume and relative size of the bubble. Overall, the model works well in detecting multiple bubbles in the S&P 500 between January 1888 and May 2010. Explosive bubbles tend to immediately precede recession periods, while collapsing bubbles tend to coincide with recession periods.

scholarly journals INVESTMENT TIMING UNDER REGIME SWITCHING

2009 ◽  
Vol 12 (04) ◽  
pp. 443-463 ◽  
Author(s):  
ROBERT J. ELLIOTT ◽  
HONG MIAO ◽  
JIN YU
Keyword(s):  
Regime Switching ◽  
Real Option ◽  
Optimal Investment ◽  
Optimal Timing ◽  
Investment Timing ◽  
Investment Opportunities ◽  
Investment Cost ◽  
State Of The Economy ◽  
Information Sets ◽  
Option Model

We investigate the optimal investment timing strategy in a real option framework. Depending on the state of the economy, whose changes are modeled by a Markov chain, the investment cost can take one of two values. The optimal investment timing decision is determined by finding the free boundary of a perpetual American option. Three investment timing policies, based on different assumptions of investors' information sets, are determined and compared. In the full information case, a significantly earlier optimal exercising time is indicated. We show that an optimal-timing policy suggested by the conventional real option model might ruin the investment opportunities.

Regime Switching with Time-Varying Transition Probabilities

2020 ◽  
pp. 144-166 ◽  
Author(s):  
FRANCIS X. DIEBOLD ◽  
JOON-HAENG LEE ◽  
GRETCHEN C. WEINBACH
Keyword(s):  
Regime Switching ◽  
Transition Probabilities ◽  
Time Varying
Sign in / Sign up

Export Citation Format

Share Document