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Are the Dynamic Linkages Between the Macroeconomy and Asset Prices Time-Varying?

Guidolin, M. and Ono, S. (2006) Are the Dynamic Linkages Between the Macroeconomy and Asset Prices Time-Varying? Journal of Economics and Business, 58 (5-6). pp. 480-518. ISSN 0148-6195

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Abstract

We estimate a number of multivariate regime switching VAR models on a long monthly US data set for eight variables that include excess stock and bond returns, the real T-bill yield, predictors used in the finance literature (default spread and the dividend yield), and three macroeconomic variables (inflation, industrial production growth, and a measure of real money growth). Heteroskedasticity may be accounted for by making the covariance matrix a function of the regime. We find evidence of four regimes and of time-varying covariances. We show that the best in-sample fit is provided by a four state model in which the VAR(1) component fails to be regime-dependent. We interpret this as evidence that the dynamic linkages between financial markets and the macroeconomy have been stable over time. The four-state model can be helpful in forecasting applications and provides one-step ahead predicted Sharpe ratios.

Item Type: Article
Keywords: Predictability; Multivariate regime switching; Predictive density tests; Sharpe ratios
Academic Units: The University of York > Economics and Related Studies (York)
Depositing User: York RAE Import
Date Deposited: 03 Aug 2009 15:15
Last Modified: 03 Aug 2009 15:15
Published Version: http://dx.doi.org/10.1016/j.jeconbus.2006.06.009
Status: Published
Publisher: Elsevier
Identification Number: 10.1016/j.jeconbus.2006.06.009
URI: http://eprints.whiterose.ac.uk/id/eprint/6628

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