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Monte Carlo Likelihood-Ratio Tests for Markov Switching Models

Staff analytical paper 2026-34 Gabriel Rodriguez Rondon, Jean-Marie Dufour
This paper develops Monte Carlo likelihood-ratio tests for determining the number of regimes in Markov switching models. Unlike most existing procedures, which focus on testing one versus two regimes, the proposed methods allow testing an arbitrary number of regimes. They are valid in finite samples, robust to identification problems, and applicable to nonstationary, multivariate, and Markov switching GARCH models.