Mastering Python for Finance - Second Edition

Smooth transition models

Abrupt regime changes in the threshold models appear to be unrealistic against real-world dynamics. This problem can be overcome by introducing a smoothly-changing continuous function from one regime to another. The SETAR model becomes a logistic smooth transition threshold autoregressive (LSTAR) model with the logistic function of G(y_t−1;γ,c):

The SETAR model now becomes an LSTAR model, as shown in the following equation:

The γ parameter controls the smooth transition from one regime to another. For large values of ...