Forecasting turbulence in the Asian and European stock market using regime-switching models

Janina Engel; Markus Wahl; Rudi Zagst; Janina Engel; Markus Wahl; Rudi Zagst

doi:10.3934/QFE.2018.2.388

Quantitative Finance and Economics

2018, Volume 2, Issue 2: 388-406. doi: 10.3934/QFE.2018.2.388

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Research article Special Issues

Forecasting turbulence in the Asian and European stock market using regime-switching models

1.
European Commission, Joint Research Centre (JRC), Directorate for Growth and Innovation,Financial and Economic Analysis Unit, Via E. Fermi 2749, 21027 Ispra (VA), Italy
2.
Chair of Mathematical Finance, Technical University of Munich, Parkring 11, 85748 Garching,Germany

Received: 23 October 2017 Accepted: 03 January 2018 Published: 01 June 2018
JEL Codes: C34, C53, G11, G15

An early warning system to timely forecast turbulences in the Asian and European stock market is proposed. To ensure comparability, the model is constructed analogously to the early warning system for the US stock market presented by Hauptmann et al. (2014). Based on the time series of discrete monthly returns of the Nikkei 225 and the EuroStoxx 50, filtered probabilities are estimated by two successive Markov-switching models with two regimes each. The market is thus separated in three states: calm, turbulent positive and turbulent negative. Subsequently, a forecasting model using logistic regression and economic input factors is selected. In an empirical asset management case study it is illustrated that the investment performance is improved when considering the signals of the established warning system. Moreover, the US, Asian and European model are compared and interdependencies are highlighted.
- early warning system,
- logistic regression models,
- Markov-switching models
Citation: Janina Engel, Markus Wahl, Rudi Zagst. Forecasting turbulence in the Asian and European stock market using regime-switching models[J]. Quantitative Finance and Economics, 2018, 2(2): 388-406. doi: 10.3934/QFE.2018.2.388

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Abstract

An early warning system to timely forecast turbulences in the Asian and European stock market is proposed. To ensure comparability, the model is constructed analogously to the early warning system for the US stock market presented by Hauptmann et al. (2014). Based on the time series of discrete monthly returns of the Nikkei 225 and the EuroStoxx 50, filtered probabilities are estimated by two successive Markov-switching models with two regimes each. The market is thus separated in three states: calm, turbulent positive and turbulent negative. Subsequently, a forecasting model using logistic regression and economic input factors is selected. In an empirical asset management case study it is illustrated that the investment performance is improved when considering the signals of the established warning system. Moreover, the US, Asian and European model are compared and interdependencies are highlighted.

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