An Explanation Model of Regime Shifts in the Tehran Stock Exchange by Smooth Transfer Regression

Document Type : Research Paper


1 Associate Prof., Department of Financial Management and Insurance, Faculty of Management and Accounting, Shahid Beheshti University, Tehran, Iran.

2 Ph.D. Candidate, Department of Finance Management, Faculty of Management and Accounting, University of Shahid Beheshti, Tehran, Iran.


Objective: Stock markets are extremely volatile and contain only a small predictable component that may still be economically justifiable and could be translated into substantial utility gains for a risk-averse investor. Moreover, the degree of return predictability varies over time and the predictive power of some instruments appears to be diminishing in recent decades. Presumably, the structural relationship between economic predictor variables and future stock returns is time-varying or regime-dependent. Identifying the prevailing macroeconomic state and risk regime is thus highly beneficial for meaningful portfolio management. Therefore, the purpose of this paper is to develop a model for switching regimes in the Tehran Stock Exchange (TSE) index return and to determine the transit variables among economic and financial variables.
Methods: The approach used in this paper is based on the smooth transition regression model. Therefore, the statistical data of the 2006-2019 period were used, based on the frequency of seasonal data for TEDPIX returns and economic and financial variables including inflation rate, interest rate, GDP, exchange rate, oil price, money supply, price-to-earnings (P/E) ratio, and price-to-book (P/B) ratio.
Results: The fitted model showed that the rate of return on the Tehran Stock Exchange index continuously switches from a lower inefficient regime to an upper inefficient one. This study confirmed the relationship between explanatory variables and stock returns is nonlinear and the existence of multiple regimes governing the, return of the TSE index as well as the importance of accounting for nonlinearity and the cyclical behavior of stock returns.
Conclusion: According to the obtained results index returns and explanatory variables have a nonlinear and asymmetric relationship and among the explanatory variables of economic and financial, the exchange rate is a transition variable. The regression coefficients during the establishment of the low fluctuations regime and higher fluctuations regime are different. Same as previous studies, the current analysis featured a range of important financial and macroeconomic factors for determining the behavior of stock returns. The results provided evidence that the real significance of the influence of factors such as exchange rate is only revealed once regimes are explicitly modeled.


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