Abstract
The Markov-switching GARCH model offers rich dynamics to model financial data. Estimating this path dependent model is a challenging task because exact computation of the likelihood is infeasible in practice. This difficulty led to estimation procedures either based on a simplification of the model or not dependent on the likelihood. There is no method available to obtain the maximum likelihood estimator without resorting to a modification of the model. A novel approach is developed based on both the Monte Carlo expectation–maximization algorithm and importance sampling to calculate the maximum likelihood estimator and asymptotic variance–covariance matrix of the Markov-switching GARCH model. Practical implementation of the proposed algorithm is discussed and its effectiveness is demonstrated in simulation and empirical studies.
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