Markov-Switching Cointegration Test for Bubbles during the Interwar European Hyperinflations

Abstract

The purpose of this paper is to test for the presence of price and exchange rate bubbles in Cagan's model using data from the interwar European hyperinflations of Germany, Hungary, and Poland. Markov-switching cointegration test would be adopted for the empirical analysis. Then, the regime-shifting behaviour of time series variables is assumed to depend on unobservable states generated by a first-order Markov chain. The probability law that governs the Markov-switching regimes is advantageous in that it is more flexible and allows the data to determine the specific form of nonlinearities that are consistent with the sample information. Inferences about the probabilities of the unobservable states at each point in time can also be made.