Regime Switching in the Presence of Endogeneity

In this paper, we propose a state-varying endogenous regime switching model (the SERS model), which includes the endogenous regime switching model by Chang, Choi and Park (2017), the CCP model, as a special case. To estimate the unknown parameters involved in the SERS model, we propose a maximum likelihood estimation method. Monte Carlo simulation results show that in the absence of state-varying endogeneity, the SERS model and the CCP model have similar performance, while in the presence of state-varying endogeneity, the SERS model performs much better than the CCP model. Finally, we use the SERS model to analyze the China stock market returns and our empirical results show that there exists strongly state-varying endogeneity in volatility switching for the Shanghai Composite Index returns. Moreover, the SERS model can indeed produce a much more realistic assessment for the regime switching process than the one obtained by the CCP model