Financial fluctuations in the Tunisian repressed market context: a Markov-switching–GARCH approach

Abstract

Small open economies are not immune to financial shocks. Fluctuations arising there interest more and more decision makers as they influence their policies’ effectiveness. A common belief is that opening the capital account is the primary source of financial instability. In this article we show that even if a capital account is not previously opened in Tunisia, the investor sentiment plays the role of the transmission channel of financial fluctuations. On monthly data (2000:01–2010:03) we filter financial business cycles via the Hodrick–Prescott procedure. Also we establish their turning points in Tunisian, Moroccan and French markets using the Bry–Boschan algorithm. Thus we build the investor sentiment index in Tunisia. Then we use it for the estimation of the financial volatility through a Markov switching–GARCH model. We show that business financial cycles in Tunisia are partially synchronized with those in France and the Tunisian investor’s sentiment is a significant explicative variable of the financial volatility. Therefore, we recommend a financial stabilization policy based on agent’s expectations for better macroeconomic effectiveness policies.