A 2-COUNTRY MODEL OF STOCHASTIC OUTPUT WITH CHANGES IN REGIME

This paper evaluates the transmission of business cycles between countries and presents evidence that world-wide shocks dominate any transmission of business cycles. I examine industrial production and look at the relationships of the United States with Canada, Germany and the United Kingdom. In the process, I present a specialized Markov-switching time-series model and evaluate it relative to other more familiar stochastic models. I show that for the data sets considered, Markov-switching models have much better goodness of fit, but larger forecast variance relative to ARMA or VAR models. © 1991.