Components of Bull and Bear Markets: Bull Corrections and Bear Rallies
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Existing methods of partitioning the market index into bull and bear
regimes do not identify market corrections or bear market rallies. In
contrast, our probabilistic model of the return distribution allows for
rich and heterogeneous intraregime dynamics. We focus on the
characteristics and dynamics of bear market rallies and bull market
corrections, including, for example, the probability of transition from a
bear market rally into a bull market versus back to the primary bear
state. A Bayesian estimation approach accounts for parameter and regime
uncertainty and provides probability statements regarding future regimes
and returns. We show how to compute the predictive density of long-horizon
returns and discuss the improvements our model provides over benchmarks.
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