Identifying turbulent and calm regimes in stock prices: evidence from the Taiwan stock market

Abstract

In this article, we apply the innovation regime-switching model, recently proposed by Kuan et al. (2005, JBES), to identify turbulent and calm regimes in stock prices. Based on the predictions of both regimes, we construct simple trading rules and investigate their profitability. Our results suggest that the proposed trading rules outperform the buy-and-hold strategy.

Notes

¹TSMC (Taiwan semiconductor Manufacturing Company) is the world's largest dedicated semiconductor foundry. The company's manufacturing capacity is currently about 4.3 million wafers, while its revenues represent some 50% of the global foundry market.

²A bottom strangle strategy, denoted as + C + P, involves buying a call and a put with different strike prices. A bottom protective strategy, denoted as − S + 2C, consists of a short position in a stock plus two long positions in a call option. The reverse positions of these strategies are denoted as − C − P and + S − 2C, respectively.

³Because the put covered warrant contingent on the TSMC stock is not available before April 2003, we consider only the data from 1 April 2003 to 31 December 2003.

⁴We also apply the IRS model to other stock prices (e.g. Fubon Financial Holding Company and Mega Financial Holding Company) in Taiwan and obtain similar results. These results are not reported but available upon request.