Regime Shifts in the Philippine Stock Market Returns

Ricardo R. Medina, Jr.

Background of the Study
Trends in the financial market are often seen due to risks associated to the growth or
decline of the industries. There are some risks due to the overall performance of a certain
industry or company which may affect other industry indirectly, since the risk is internally
incurred. There are also risks that make most of the industries financially gain or lose which
originate mostly outside of the market, like shifts in government policies, natural or man-made
disasters, epidemics like H1N1 and Ebola virus outbreak, or financial crisis from the other side
of the world, Asian financial crisis of 1997 and the Global financial crisis of 2008 which is the
worst since the Great Depression, to name a few.
These trends or shifts are of great importance not just for the investor and on the financial
sector but for the whole economy as well. After studying these shifts, one can devise a strategy
to make his or her investment allocation optimal. Measures can be implemented by policy
makers and the government to boost the confidence of the financial authorities which in turn also
affect each and everyone in the society economically.
One of the strategies to analyze the trends is by using the model and one of them, which
is commonly used for stock market returns is the Markov-switching autoregressive model. This
model is designed to look into sudden shifts in the series, in this case the daily stock market
returns. This model is different for other time series models in the sense that this model captures
shifts in the mean, variance and the parameters of the autoregressive process and that, is
nonlinear, from which, we are able to look into several properties of the series.
Statement of the Problem
There are some existing researches tackling on the relationship between major stock
market returns in which the Philippines is integrated. Tan (2012) studied the relationship of stock
returns of the major world index returns and the Philippines and found out that there is a weak
relationship between the returns but noted that there exists a strong relationship among regional
markets. In a study of Wang and Theobald (2007), their results exhibited strong evidence of at
least two regimes for each of the six emerging East Asian markets including the Philippines.
Other studies analyze the degree of relationships between the sector and the main index
returns of the stock markets present in their countries. Isa and Ismail (2008) used Markov
switching autoregressive model to identify regime shifts in the four indices of Bursa Malaysia
(Malaysian stock exchange) which are the Composite Index, Industrial Index, Financial Index
and Property Index. Bandi & Wasim (2011) studied the forecast of their model for the leading

indexes in India (BSE-Sensex and NSE-Nifty) and predicted that the market will remain in bull
or strong regime.
From these previous researches, this paper attempts to identify existing relationships and
identify regime shifts among the leading indices in the Philippine stock market.
Objectives of the Study
This study generally aims to identify the regime shifts in the stock returns of the
Philippine market. Specifically, this study intends to identify the degree of relationship between
the composite and sector indexes of the Philippine Stock Exchange (PSE) and to determine the
regime shifts in the mean and variance of the composite and sector indices of the PSE.
Scope and Limitations of the Study
This study will only cover stock market returns of the PSE Composite and Sector Indexes
from October 2004 to October 2014. A two-regime Markov switching autoregressive model will
be used to capture the behaviour of the regime shifts.
References:
Bandi, K. & Wasim, A. (2011). Identifying regime shifts in Indian stock market: A Markov
switching approach. Munich Personal RePEc Archive. Retrieved from http://mpra.ub.unimuenchen.de/37174/1/MPRA_paper_37174.pdf
Isa, Z. & Ismail, M. T. (2008). Identifying regime shifts in Malaysian stock market returns.
International Research Journal of Finance and Economics, 15, 44-57. Retrieved from
http://www.researchgate.net/publication/231216376_Identifying_Regime_Shifts_in_Mal
aysian_Stock_Market_Returns/links/0fcfd5066075e61a85000000
Tan, T. A. (2012). Stock market integration: Case of the Philippines. Philippine Management
Review, 19, 75-90. Retrieved from http://journals.upd.edu.ph/index.php/pmr/article/vie
wFile/2 795/2608
Wang P. & Theobald, M. (2007). Regime switching volatility of six East Asian emerging
markets. Research in International Business and Finance, 22, 267-283.