Why Markov Switching Models Work Well: An Explanation

In general, the probability of the next state depends not only on the current state, but also on the whole pre-history. However, in practice, many real-life processes — including economic processes — can be well described by so-called Markov models, i.e., models in which the probability of the next state depends only on the current state. In this paper, we explain the empirical ubiquity of such models.