ABSTRACT
Recent renewed interest in Markov chain processes and Markov switching models was largely stimulated by Hamilton (1989, 1994). While the major contributors with economic significance to the popularity of this family of models are the intensified studies in business cycles in the last two decades on the frontiers of macro and monetary economics, and the proliferating use of mathematical tools in the exploitation of excess returns in a seemingly efficient while volatile financial market. The regime shift or state transition features of Markov switching, when applied properly, are able to illustrate and explain economic fluctuations around boom-recession or more complicated multiphase cycles. In financial studies, the state transition process can be coupled with bull-bear market alternations, where regimes are less clearly defined but appear to have more practical relevance. However, estimation of Markov switching models may be technically difficult and the results achieved may be sensitive to the settings of the procedure. Probably, rather than producing a set of figures of immediate use, the approach helps improve our understanding about an economic process and its evolvingmechanism constructively, as with many other economic and financial models.
