G. Perez-quiros et A. Timmermann, Business cycle asymmetries in stock returns: Evidence from higher order moments and conditional densities, J ECONOMET, 103(1-2), 2001, pp. 259-306
Markov switching models with time-varying means, variances and mixing weigh
ts are applied to characterize business cycle variation in the probability
distribution and higher order moments of stock returns. This allows us to p
rovide a comprehensive characterization of risk that goes well beyond the m
ean and variance of returns. Several mixture models with different specific
ations of the state transition are compared and we propose a new mixture of
Gaussian and student-t distributions that captures outliers in returns. Th
e models produce very similar expected returns and volatilities but imply v
ery different time series for conditional skewness, kurtosis and predictive
density. Consistent with economic theory, the gains in predictive accuracy
from considering two-state mixture models rather than a single-state speci
fication are higher for small fil ms than for large firms. (C) 2001 Publish
ed by Elsevier Science S.A.