Markov Switches and Extreme Events
Markov Switches and Extreme Events
This chapter examines the effects of a dramatic switch in the dynamics of economic growth for the term structure of the discount rate over the longer term. Economies undergo radical transformations. One such radical transformation was called the “industrial revolution” which has had a long-lasting effect on economic growth. The chapter considers the possibility of a reversion to the pre-industrial age, at least in terms of an absence of growth, in the distant future, or any other effects on the current economic growth rate. Other less persistent—but more frequent—transformations observed in the past were wars or great economic depressions. It is thus important to include the possibility of such changes in the dynamics of growth in the analysis of the term structure of the discount rate.
Keywords: term structure, economic growth, extreme events, Markov switches, random walk, radical economic transformations, economic depressions, economic reversions, discount rate
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