Regime Switching

What is Regime Switching?

Volatilities are frequently expected to fluctuate slowly when modelling data. This indicates that times of high volatility are commonly followed by periods of low volatility and vice versa.

Volatilities, on the other hand, can alter swiftly and abruptly. Regime changeover is what happens when this happens.

Example of Regime Switching:

An unexpected central bank or government announcement may cause market volatility to jump at first, then fall rapidly once markets have digested the information.

Why is Regime Switching important?

The regime-switching model allows us to represent the potential state-contingent behaviour of the SCDS spread while enabling the influence of different explanatory variables to change under various economic and market conditions.