Measuring Volatility Regime Switching and Volatility Contagion: A Range-based Volatility Approach

This article proposes a new approach to evaluate volatility regime switching and volatility contagion in financial markets. A time-varying conditional autoregressive range (TVCARR) model is proposed to capture possible regime switching in the range process. A misspecification test for the conditional autoregressive range (CARR) model against the TVCARR model is introduced. The finite-sample properties of the test are discussed by simulation. Copula functions are used to construct the bivariate TVCARR model. The approach is applied to the stock markets of the G7 in order to investigate the impact of the subprime mortgage crisis. The evidence shows that volatility regime switching occurred in all the seven markets, while only four of the six markets experience volatility contagion from the U.S. market.