The Dynamic Analysis and Prediction of Stock Markets through the Latent Markov Model

Abstract

In this paper we show how the latent Markov model can be used to define different conditions in the stock market, called market-regimes. Changes in regimes can be used to detect financial crises, pinpoint the end of a crisis and predict future developments in the stock market, to some degree. The model is applied to changes in monthly price indexes of the Italian and US stock market in the period from January 2000 to July 2009.