The HMM can be used in the finance field for a great number of things. Features such as regime identification, volatility clustering, and anti-correlation (return and volatility) can all be extracted from financial data through using the HMM. R has several great packages to deal with the HMM. This chapter uses one called ldhmm, which implements the homogeneous first-order HMM.
This link will guide you through the package documentation: https://cran.r-project.org/web/packages/ldhmm/ldhmm.pdf. The word first-order means that the state in time t is only influenced by the state in time t-1. Make sure that you have ldhmm installed by using the following code:
if(!require('ldhmm')){install.packages('ldhmm')}
Let's begin with data. The ldhmm package comes with daily data from the Standard & Poor 500 Index (SPX). Run the following...