Do Markov-switching Models Capture Nonlinearities in the Data? Test Using Nonparametric Methods

Markov-switching models have become popular alternatives to linear autoregressive models. Many papers which estimate nonlinear models make little attempt to demonstrate whether the nonlinearities they capture are of interest or if the models differ substantially from the linear option. By simulating the models and nonparametrically estimating functions of the simulated data, we can evaluate if and how the nonlinear and linear models differ.