Markov regime-switching models for stock returns along with exchange rates and interest rates in Korea

Abstract

We apply the Hamilton 2-regime Markov Switching model to the stock returns along with exchange rates and interest rates from January 1993 to December 2016 in Korea. Two regimes are distinct in the Korean stock market. In regime 1 with low-volatility, the stock returns of Korea are significantly affected first by their exchange rates and secondly by their interest rates. More precisely, both exchange rates and interest rates negatively influence the stock returns during relatively stable periods in Korea. In regime 2 with high-volatility, the Korean stock market is explained by none of the two explanatory variables.