Changes in nominal interest rates must be due to either movements in real interest rates, expected inflation, or the inflation risk premium. We develop a term structure model with regime switches, time-varying prices of risk, and inflation to identify these components of the nominal yield curve. We find that the unconditional real rate curve is fairly flat at 1.44%, but slightly humped. In one regime, the real term structure is steeply downward sloping. Real rates (nominal rates) are pro-cyclical (counter-cyclical) and inflation is negatively correlated with real rates. An inflation risk premium that increases with the horizon fully accounts for the generally upward sloping nominal term structure. We find that expected inflation drives about 80 % of the variation of nominal yields at both short and long maturities, but during normal times, all of the

An autoregressive process with Markov regime is an autoregressive process for which the regression function at each time point is given by a nonobservable Markov chain. In this paper we consider the asymptotic properties of the maximum likelihood estimator in a possibly nonstationary process of this kind for which the hidden state space is compact but not necessarily finite. Consistency and asymptotic normality are shown to follow from uniform exponential forgetting of the initial distribution for the hidden Markov chain conditional on the observations.

Though Hamilton's (1989) Markov switching model has been widely estimated in various contexts, formal testing for Markov switching is not straightforward. Univariate tests in the classical framework by Hansen (1992) and Garcia (1998) do not reject the linear model for GDP. We present Bayesian tests for Markov switching in both univariate and multivariate settings based on sensitivity of the posterior probability to the prior. We #nd that evidence for Markov switching, and thus the business cycle asymmetry, is stronger in a switching version of the dynamic factor model of Stock and Watson (1991) than it is for GDP by itself. Key Words: Bayesian Model Selection, Business Cycle Asymmetry, Dynamic Factor Model, Pseudo Prior, Model Indicator Parameter, Test of Markov Switching. JEL Classi#cations: C11, C12, E32. \The Bayesian moral is simple: Never make anything more than relative probability statements about the models explicitly entertained. Be suspicious of those who promise more!" [Po...

We propose a generalization of existing business cycle models which allows us to decompose recessions into permanent and transitory components. We find that the transitory component of recessions accounts for between 77% and 96% of the observed variance of monthly indicator series. Our results suggest the following three phase characterization of the business cycle: recession, high-growth recovery during which output partially reverts to its previous peak, and normal growth following the recovery. In addition, we find significant timing differences between the permanent and transitory components of recessions; most notably the lack of the usual high-growth recovery phase following the 1990-91 recession. JEL Codes: C32, E32 Kim: Department of Economics, Korea University, Seoul, 136-701, Korea (cjkim@kuccnx.korea.ac.kr); Murray: (Corresponding author) Department of Economics, University of Houston, Houston, TX 77204-5882 (cjmurray@uh.edu), Tel: 713-743-3835, Fax: 713-743-3798 1 1. In...

1 A previous draft of this paper was circulated under the title “Exact likelihood-based estimation of conditionally heteroskedastic factor models”. We are grateful to Manuel Arellano, Sid Chib, Antonis

Abstract. This paper applies regime switching methods to the problem of measuring monetary policy. Policy preferences and structural factors are specified parametrically as independent Markov processes. Interaction between the structural and preference parameters in the policy rule serves to identify the two processes. The estimates uncover policy episodes that are initiated by switches to “dove regimes,” shown to Granger cause both NBER recessions and the Romer dates. These episodes imply real effects of monetary policy that are smaller than those found in previous studies. 1.

In a series of papers based on analogies with statistical physics models, we have proposed that most nancial crashes are the climax of so-called log-periodic power law signatures (LPPS) associated with speculative bubbles [Sornette and Johansen, 1998, Johansen and Sornette, 1999, Johansen et al., 1999, Johansen et al., 1999, Sornette and Johansen, 2001]. In addition, a large body of empirical evidence supporting this proposition have been presented [Sornette et al., 1996, Sornette and Johansen, 1998, Johansen et al., 1999, Johansen and Sornette, 2000, Johansen and Sornette, 2001b, Sornette and Johansen, 2001]. Along a complementary line of research, we have established that, while the vast majority of drawdowns occurring on the major nancial markets have a distribution which is well-described by a stretched exponential, the largest drawdowns are occurring with a signi cantly larger rate than predicted by extrapolating the bulk of the distribution and should thus be considered as outliers [Johansen and Sornette, 1998, Sornette and Johansen, 2001, Johansen and Sornette, 2001b, Johansen, 2002]. Here, these two lines of research are merged in a systematic way to oer a classi cation of crashes as either events of an endogenous origin associated with preceding speculative bubbles or as events of an exogenous origin associated with the markets response to external shocks.

Stylized facts show that average growth rates of US per capita consumption and income differ in recession and expansion periods. Since a linear combination of such series does not have to be a constant mean process, standard cointegration analysis between the variables to examine the permanent income hypothesis may not be valid. To model the changing growth rates in both series, we introduce a multivariate Markov trend model, which accounts for di#erent growth rates in consumption and income during expansions and recessions and across variables within both regimes. The deviations from the multivariate Markov trend are modeled by a vector autoregressive model. Bayes estimates of this model are obtained using Markov chain Monte Carlo methods. The empirical results suggest the existence of a cointegration relation between US per capita disposable income and consumption, after correction for a multivariate Markov trend. This results is also obtained when per capita investment is added to the vector autoregression.

Friedman’s ‘plucking ’ model, in which output cannot exceed a ceiling level but is occasionally plucked downward by recessions, is tested using Kim and Nelson’s formal econometric specification on output data from the G-7 countries. Considerable support for the model is obtained, leading us to conclude that during normal periods, output seems to be driven mostly by permanent shocks, but during recessions and highgrowth recoveries, transitory shocks dominate. During these periods macroeconomic models that emphasise demand-oriented shocks, rather than real business cycle type models, may thus be more appropriate. Keywords: BUSINESS CYCLE ASYMMETRY, STATE SPACE MODELS, G-7 COUNTRIES, MARKOV SWITCHING

We propose to use the attractiveness of pooling relatively short time series that display similar dynamics, but without restricting to pooling all into one group. We suggest to estimate the appropriate grouping of time series simultaneously along with the group-specific model parameters. We cast estimation into the Bayesian framework and use Markov chain Monte Carlo simulation methods. We discuss model identification and base model selection on marginal likelihoods. A simulation study documents the efficiency gains in estimation and forecasting that are realized when appropriately grouping the time series of a panel. Two economic applications illustrate the usefulness of the method in analyzing also extensions to Markov switching within clusters and heterogeneity within clusters, respectively. JEL classification: C11,C33,E32