Markov Breaks in Regression Models

Markov Breaks in Regression Models. Smith, A. Journal of Time Series Econometrics, De Gruyter, 2012.

This article develops a new Markov breaks (MB) model for forecasting and making inference in linear regression models with breaks that are stochastic in both timing and magnitude. The MB model permits an arbitrarily large number of abrupt breaks in the regression coefficients and error variance, but it maintains a low-dimensional state space, and therefore it is computationally straightforward. In particular, the likelihood function can be computed analytically using a single iterative pass through the data and thereby avoids Monte Carlo integration. The model generates forecasts and conditional coefficient predictions using a probability weighted average over regressions that include progressively more historical data. I employ the MB model to study the predictive ability of the yield curve for quarterly GDP growth. I show evidence of breaks in the predictive relationship, and the MB model outperforms competing breaks models in an out-of-sample forecasting experiment.

@article{smith2012markov,
  title={Markov Breaks in Regression Models},
  author={Smith, Aaron},
  journal={Journal of Time Series Econometrics},
  volume={4},
  number={1},
  year={2012},
	url={https://files.asmith.ucdavis.edu/2012_JTSEmet_S_MB.pdf},
	keywords={econometrics},
	abstract={This article develops a new Markov breaks (MB) model for forecasting and making inference in linear regression models with breaks that are stochastic in both timing and magnitude. The MB model permits an arbitrarily large number of abrupt breaks in the regression coefficients and error variance, but it maintains a low-dimensional state space, and therefore it is computationally straightforward. In particular, the likelihood function can be computed analytically using a single iterative pass through the data and thereby avoids Monte Carlo integration. The model generates forecasts and conditional coefficient predictions using a probability weighted average over regressions that include progressively more historical data. I employ the MB model to study the predictive ability of the yield curve for quarterly GDP growth. I show evidence of breaks in the predictive relationship, and the MB model outperforms competing breaks models in an out-of-sample forecasting experiment.},
  publisher={De Gruyter}
}

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