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Markov Regime Switching Model Case Study

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Foreign exchange is significant in many different parts of the economy. It is mainly used in international trade and debt servicing. It is also important in the insurance industry because there are plans, such as multi-currency plans, which are designed with benefits and premiums define in terms of different currencies. Also, investment banks and multinational companies loan and/or invest part of their capital in terms of the foreign currency (BSP, 2008). Foreign exchange rate is complex and hence it is heavily studied in international macroeconomics.

Foreign exchange rate may also be defined as the relationship between the term structures of interest rates of several national currencies. This relationship changes continuously because of …show more content…

Because of the accuracy and efficiency of these models in analyzing financial time series data, it is applied commonly in stock returns, as well as to other financial derivatives. It is also used in examining the trends of foreign currency rates. In 2004, Kóbor and Székely assessed the feasibility of Euro adoption of four central EU accession countries by examining their foreign exchange market volatilities using regime-switching models. Ismail and Isa (2006) also derived various regime-switching models and fitted in the Malaysian, Thai, and Singaporean exchange rates. Both papers had established that Markov regime-switching models provide better in-sample fitting than linear models and single regime models, and it can detect structural breaks and mean reversion in the data.

V. Scope and Limitations

In this study, the Philippine Peso per European Dollar average monthly exchange rates from January 1994 to February 2014 are the only data considered. Other data from the foreign exchange market and the average monthly exchange rates from other months not within the said range are not included in this study.

VI. Significance of the Study

The study is significant to many fields and people. It can help financial analysts and economic managers in the government to predict the general trend and movement of the foreign currency market, with the Peso per Dollar exchange rate as main focus, for optimal policies pertaining to some economic

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