Abstract

This paper makes an attempt to identify the periods of high illiquidity spiral and loss spiral fitting into Markov switching regimes model with Constant Transition Probability and Time-Varying Transition Probability models in US equity market. We identified two different states of the illiquidity spiral and loss spiral in the data associated with the said variables under the CPT and TVTP. However the time-varying transition probabilities for illiquidity spiral and loss spiral have changed significantly during the period under analysis and the explanatory variables are very informative in dating the evolution of the state of the illiquidity spiral and loss spiral over a period of 27 years starting with 1983. Hence TVTP model is preferred over the CTP model in identifying the illiquidity spiral and loss spiral regime switching. In particular, the probability of remaining in the high illiquidity spiral and high loss spiral regimes increases with a decrease in S&P 500 return.

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