Modelling exchange rates using regime switching models

Mohd Tahir Ismail, Zaidi Isa

Research output: Contribution to journalArticle

10 Citations (Scopus)

Abstract

The behaviour of many financial time series cannot be modeled solely by linear time series model. Phenomena such as mean reversion, volatility of stock markets and structural breaks cannot be modelled implicitly using simple linear time series model. Thus, to overcome this problem, nonlinear time series models are typically designed to accommodate these nonlinear features in the data. In this paper, we use portmanteau test and structural change test to detect nonlinear feature in three ASEAN countries exchange rates (Malaysia, Singapore and Thailand). It is found that the null hypothesis of linearity is rejected and there is evidence of structural breaks in the exchange rates series. Therefore, the decision of using regime switching model in this study is justified. Using model selection criteria (AIC, SBC, HQC), we compare the in-sample fitting between two types of regime switching model. The two regime switching models we considered were the Self-Exciting Threshold Autoregressive (SETAR) model and the Markov switching Autoregressive (MS-AR) model where these models can explain the abrupt changes in a time series but differ as how they model the movement between regimes. From the AIC, SBC and HQC values, it is found that the MS-AR model is the best fitted model for all the return series. In addition, the regime switching model also found to perform better than simple autoregressive model in in-sample fitting. This result justified that nonlinear model give better in-sample fitting than linear model.

Original languageEnglish
Pages (from-to)55-62
Number of pages8
JournalSains Malaysiana
Volume35
Issue number2
Publication statusPublished - Dec 2006
Externally publishedYes

Fingerprint

Regime-switching model
Modeling
Exchange rate regimes
Time series models
Autoregressive model
Structural breaks
Markov switching
Exchange rates
Model selection criteria
Structural change
Financial time series
Singapore
Thailand
Threshold autoregressive model
Malaysia
Mean reversion
Stock market
Linearity
Portmanteau test
Nonlinear time series

Keywords

  • Exchange rates
  • Model selection criteria
  • Nonlinearity
  • Regime switching model

ASJC Scopus subject areas

  • General

Cite this

Modelling exchange rates using regime switching models. / Ismail, Mohd Tahir; Isa, Zaidi.

In: Sains Malaysiana, Vol. 35, No. 2, 12.2006, p. 55-62.

Research output: Contribution to journalArticle

Ismail, Mohd Tahir ; Isa, Zaidi. / Modelling exchange rates using regime switching models. In: Sains Malaysiana. 2006 ; Vol. 35, No. 2. pp. 55-62.
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