Regime shifts present significant challenges for investors because they cause
performance to depart significantly from the ranges implied by long-term
averages of means and covariances. But regime shifts also present opportunities
for gain. The authors show how to apply Markov-switching models to forecast
regimes in market turbulence, inflation, and economic growth. They found that a
dynamic process outperformed static asset allocation in backtests, especially
for investors who seek to avoid large losses.