Regime Shifts and Volatility Dynamics in the Bucharest Stock Market: a Markov Switching and Arch Perspective

Abstract

This research examines the changes in volatility and shifts in regimes within the Bucharest Stock Exchange (BSE) by analysing the performance of the BET index. By utilizing both the Markov Switching Model (MSM) and Autoregressive Conditional Heteroskedasticity (ARCH) tests, the study detects two separate market conditions—bullish and bearish—and affirms the existence of volatility clustering in the Romanian market. The analysis of MSM shows a strong level of continuity in both market conditions, leading to important consequences for how investors act, such as excessive reaction, following the crowd, and fear of risk. The ARCH test emphasizes changing volatility over time, showing that market fluctuations are strongly affected by how investors collectively react to market conditions, especially in times of uncertainty or crisis. These results highlight the importance of considering behavioural biases when evaluating risk and making investment choices in emerging markets, such as Romania, for investors and policymakers. The research adds to the body of behavioural finance knowledge by offering an understanding of how investor sentiment impacts volatility and market regime shifts in emerging markets.