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Predictive power of Markovian models: Evidence from US recession forecasting

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  • Ruilin Tian
  • Gang Shen

Abstract

This paper provides extensions to the application of Markovian models in predicting US recessions. The proposed Markovian models, including the hidden Markov and Markov models, incorporate the temporal autocorrelation of binary recession indicators in a traditional but natural way. Considering interest rates and spreads, stock prices, monetary aggregates, and output as the candidate predictors, we examine the out‐of‐sample performance of the Markovian models in predicting the recessions 1–12 months ahead, through rolling window experiments as well as experiments based on the fixed full training set. Our study shows that the Markovian models are superior to the probit models in detecting a recession and capturing the recession duration. But sometimes the rolling window method may affect the models' prediction reliability as it could incorporate the economy's unsystematic adjustments and erratic shocks into the forecast. In addition, the interest rate spreads and output are the most efficient predictor variables in explaining business cycles.

Suggested Citation

  • Ruilin Tian & Gang Shen, 2019. "Predictive power of Markovian models: Evidence from US recession forecasting," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 38(6), pages 525-551, September.
    • Handle: RePEc:wly:jforec:v:38:y:2019:i:6:p:525-551
    DOI: 10.1002/for.2579
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    Citations

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    Cited by:

    1. Shuaizhang Feng & Jiandong Sun, 2020. "Misclassification-Errors-Adjusted Sahm Rule for Early Identification of Economic Recession," Working Papers 2020-029, Human Capital and Economic Opportunity Working Group.
    2. Blanchflower, David G. & Bryson, Alex, 2021. "The Economics of Walking About and Predicting Unemployment," GLO Discussion Paper Series 922, Global Labor Organization (GLO).
    3. Feng, Shuaizhang & Sun, Jiandong, 2020. "Misclassification-Errors-Adjusted Sahm Rule for Early Identification of Economic Recession," IZA Discussion Papers 13168, Institute of Labor Economics (IZA).
    4. Khatereh Ghasvarian Jahromi & Davood Gharavian & Hamid Reza Mahdiani, 2023. "Wind power prediction based on wind speed forecast using hidden Markov model," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 42(1), pages 101-123, January.
    5. Constandina Koki & Stefanos Leonardos & Georgios Piliouras, 2020. "Exploring the Predictability of Cryptocurrencies via Bayesian Hidden Markov Models," Papers 2011.03741, arXiv.org, revised Dec 2020.
    6. Vrontos, Spyridon D. & Galakis, John & Vrontos, Ioannis D., 2021. "Modeling and predicting U.S. recessions using machine learning techniques," International Journal of Forecasting, Elsevier, vol. 37(2), pages 647-671.
    7. Seulki Chung, 2023. "Real-time Prediction of the Great Recession and the Covid-19 Recession," Papers 2310.08536, arXiv.org, revised Mar 2024.
    8. Koki, Constandina & Leonardos, Stefanos & Piliouras, Georgios, 2022. "Exploring the predictability of cryptocurrencies via Bayesian hidden Markov models," Research in International Business and Finance, Elsevier, vol. 59(C).
    9. Blanchflower, David G. & Bryson, Alex, 2023. "Labour Market Expectations and Unemployment in Europe," IZA Discussion Papers 15905, Institute of Labor Economics (IZA).
    10. Feng, Shuaizhang & Sun, Jiandong, 2020. "Misclassification-errors-adjusted Sahm Rule for Early Identification of Economic Recession," GLO Discussion Paper Series 523, Global Labor Organization (GLO).
    11. Sun, Jiandong & Feng, Shuaizhang & Hu, Yingyao, 2021. "Misclassification errors in labor force statuses and the early identification of economic recessions," Journal of Asian Economics, Elsevier, vol. 75(C).

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