Who Tames the Celtic Tiger? Portfolio Implications from aMultivariate Markov Switching Model

We use multivariate regime switching vector autoregressive models to characterize the time-varyinglinkages among the Irish stock market, one of the top world performers of the 1990s, and the US andUK stock markets. We ¯nd that two regimes, characterized as bear and bull states, are required tocharacterize the dynamics of excess equity returns both at the univariate and multivariate level. Thisimplies that the regimes driving the small open economy stock market are largely synchronous withthose typical of the major markets. However, despite the existence of a persistent bull state in whichthe correlations among Irish and UK and US excess returns are low, we ¯nd that state comovementsinvolving the three markets are so relevant to reduce the optimal mean-variance weight carried by ISEQstocks to at most one-quarter of the overall equity portfolio....