STOCK-MARKET VOLATILITY AND REGIME SHIFTS IN RETURNS

This paper relates variation in stock market volatility to regime shif ts in stock market returns. We apply a Markov switching model to marke t returns and examine the variation in volatility in different return regimes. We find that stock returns are best characterized by a model containing six regimes with significantly different volatility across the regimes. Volatility is higher when returns are either above or bel ow the normal regime--the further returns deviate from the normal regi me, the higher the volatility. Furthermore, volatility is higher in ne gative return regimes than in positive return regimes. These observati ons lead us to conclude that return and volatility are related nonline arly and that the relationship is asymmetric.