2 Bayesian Analysis of Switching ARCH Models

We consider a time series model with autoregressive conditional heteroskedas-ticity that is subject to changes in regime. The regimes evolve according to a multistate latent Markov switching process with unknown transition probabilities, and it is the constant in the variance process of the innovations that is subject to regime shifts. The joint estimation of the latent process and all model parameters is performed within a Bayesian framework using the method of Markov Chain Monte Carlo simulation. We perform model selection with respect to the number of states and the number of autoregressive parameters in the variance process using Bayes factors and model likelihoods. To this aim, the model likelihood is estimated by the method of bridge sampling. The usefulness of the sampler is demonstrated by applying it to the data set previously used by Hamilton and Susmel who investigated models with switching autoregressive conditional het-eroskedasticity using maximum likelihood methods. The paper concludes with some issues related to maximum likelihood methods, to classical model selection