Markov Regime-Switching Autoregressive Model of Stock Market Returns in Nigeria

Abstract

This study is designed to model and forecast Nigeria’s stock market using the All-Share Index (ASI) as a proxy. By employing the Markov regime-switching autoregressive (MS-AR) model with data from April 2005 to September 2019, the study analyzes the stock market volatility in three distinct regimes (accumulation or distribution – regime 1; big-move – regime 2; and excess or panic phases – regime 3) of the bull and bear periods. Six MS-AR candidate models are estimated and based on the minimum AIC value, MS(3)-AR(2) is returned as the optimal model among the six candidate models. The MS(3)-AR(2) analysis provides evidence of regime-switching behaviour in the stock market. The study also shows that only extreme events can switch the ASI returns from regime 1 to regime 2 and to regime 3, or vice versa. It further specifies an average duration period of 9, 3 and 4 weeks for the accumulation/distribution, big-move and excess/panic regimes respectively which is an evidence of favorable market for investors to trade. Based on Root Mean Square Error and Mean Absolute Error, the fitted MS-AR model is adjudged the most appropriate ASI returns forecasting model. The study recommends investments in stock across the regimes that are switching between accumulation/distribution and big-move phases for promising returns.

The Regime Examination of Nigeria Exchange Rate Volatility: Evidence from Markov Regime Switching Autoregressive Approach

“…However, the transition probability and expected duration of the liquidation phase were higher than the awareness and imbalance phases. This finding is similar to Adejumo et al (2020), where higher transition probabilities were established in accumulation/distribution compared to big-move and excess/panic eras. The findings mentioned above show that the imbalance and liquidation regimes' identification and their average durations are evident that the Naira in foreign exchange market is not favourable for investors to trade.…”

“…2) estimation provides the empirical results of the Nigerian exchange rate returns in three distinct phases; imbalance, liquidation and awareness regimes. This finding is unique however, similar to Adejumo et al (2020), whose study provided evidence of financial assets in three regimes (accumulation or distributionregime 1; big-move regime 2; and excess or panic phasesregime 3). Also, evidence from the three-regimes [MS(3)-AR(2)] estimation established a high probability that the returns' system remains in the liquidation and awareness states, it implied that only unusual events could switch the series from regime 2 (liquidation phase) and regime 3 (awareness).…”