Markov-Switching Models (MSMs) are statistical tools used to analyze and predict business cycles by allowing for changes in the underlying regime of economic conditions. These models assume that the economy can switch between different states or regimes, such as periods of expansion and contraction, following a Markov process. In essence, the future state of the economy depends only on the current state, not on the sequence of events that preceded it.
Key features of Markov-Switching Models include:
Mathematically, the state at time can be represented by a latent variable that takes on discrete values, where the transition probabilities are defined as:
where represents the probability of moving from state to state . This framework allows economists to better understand the complexities of business cycles and make more informed
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