Abstract
Along the basic rationale of the Enke-Samuelson-Takajama-Judge spatial equilibrium theory and the dynamic conceptualizations made from arbitrage processes, the study explores regime-switching techniques in hidden Markov framework. This is motivated by complex non-linear structure inherent in market integration processes, which is derived from multiple equilibria conditions, and transaction costs constrained threshold autoregressive (TAR) effects. These place theoretical limitations on current time series empirical models that are applied in market integration studies. In equilibrium representation, the non-linearities imposed by both alternating rent levels and switching adjustment parameters are directly accommodated. Two synthesized time series market data sets of varying levels of non-linear structures are used to highlight the strengths and limitations of the Markov variants vis-Ã -vis the band-TAR models that have currently dominated market integration analysis. The former model could capture alternating adjustment processes implied by the relatively complex non-linear market data set while the later produced mixed results.
Highlights
In market integration (MI) modelling and analysis, three fundamental issues present challenges for parameter estimation and in effect complicate interpretation of empirical results
Results from Band-Tar and Markovian Models: In Table 1 below, b-threshold autoregressive (TAR) model is used to analyse series A presented above to conclude on the implied inter-market processes by assuming that the data generating processes (DGP) is of transaction costs (TC) constrained threshold type
Unlike the band-threshold autoregressive (b-TAR) structure, the MS-EM is not affected by the mixed adjustment patterns once some sort of state transition persistence exists with the periods of inter-market anomalies as it uses sub-samples extracted in vertical windows
Summary
In market integration (MI) modelling and analysis, three fundamental issues present challenges for parameter estimation and in effect complicate interpretation of empirical results. These are data availability and quality, theoretical and conceptual contextualisation, and as a result the choice for empirical model structure to be applied. If all economic time series data of the markets are available or observable, one can conclude such patterns from data on transaction costs, trade quotas/volumes and price series as equilibrium theories postulate. Profit levels could be constructed to classify the markets into successful or failed arbitrage conditions as well as disintegrated/integrated outcomes given data on tradability
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