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Econometrics: Models of Regime Changes

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Encyclopedia of Complexity and Systems Science

Definition of the Subject

Regime‐switching models are time-series models in whichparameters are allowed to take on different values in each of some fixed number of “regimes.” A stochastic process assumed tohave generated the regime shifts is included as part of the model, which allows for model-basedforecasts that incorporate the possibility of future regime shifts. In certain specialsituations the regime in operation at any point in time is directly observable. More generally the regime is unobserved, and the researcher mustconduct inference about which regime the process was in at past points in time. The primary use of these models in the applied econometricsliterature has been to describe changes in the dynamic behavior of macroeconomic and financial time series.

Regime‐switching models can be usefully divided into two categories: “threshold” models and “Markov‐switching” models. The primary difference between these approaches is in how the evolution ofthe...

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Abbreviations

Filtered probability of a regime:

The probability that the unobserved Markov chain for a Markov‐switching model is in a particular regime in period t, conditional on observing sample information up to period t.

Gibbs sampler:

An algorithm to generate a sequence of samples from the joint probability distribution of a group of random variables by repeatedly sampling from the full set of conditional distributions for the random variables.

Markov chain:

A process that consists of a finite number of states, or regimes, where the probability of moving to a future state conditional on the present state is independent of past states.

Markov‐switching model:

A regime‐switching model in which the shifts between regimes evolve according to an unobserved Markov chain.

Regime‐Switching Model:

A parametric model of a time series inwhich parameters are allowed to take on different values in each ofsome fixed number of regimes.

Smooth transition threshold model:

A threshold model in which the effect of a regime shift on model parameters is phased in gradually, rather than occurring abruptly.

Smoothed probability of a regime:

The probability that the unobserved Markov chain for a Markov‐switching model is in a particular regime in period t, conditional on observing all sample information.

Threshold model:

A regime‐switching model in which the shifts between regimes are triggered by the level of an observed economic variable in relation to an unobserved threshold.

Time-varying transition probability:

A transition probabilityfor a Markov chain that is allowed to vary depending on the outcome of observed information.

Transition probability:

The probability that a Markov chain will move from state j to state i.

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Authors and Affiliations

  1. Department of Economics, University of Oregon, Eugene, USA

    Jeremy Piger

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  1. Jeremy Piger
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Editors and Affiliations

  1. RAMTECH LIMITED, 122 Escalle Lane, Larkspur, CA, 94939, USA

    Robert A. Meyers Ph. D. (Editor-in-Chief) (Editor-in-Chief)

Additional information

I am grateful to Jim Hamilton and Bruce Mizrach for comments on an earlier draft.

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Piger, J. (2009). Econometrics: Models of Regime Changes. In: Meyers, R. (eds) Encyclopedia of Complexity and Systems Science. Springer, New York, NY. https://doi.org/10.1007/978-0-387-30440-3_165

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