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Financial indicators and density forecasts for US output and inflation

Author

Listed:
  • Piergiorgio Alessandri

    (Bank of Italy)

  • Haroon Mumtaz

    (Queen Mary University of London)

Abstract

When do financial markets help in predicting economic activity? With incomplete markets, the link between financial and real economy is state-dependent and financial indicators may turn out to be useful particularly in forecasting "tail" macroeconomic events. We examine this conjecture by studying Bayesian predictive distributions for output growth and inflation in the US between 1983 and 2012, comparing linear and nonlinear VAR models. We find that financial indicators significantly improve the accuracy of the distributions. Regime-switching models perform better than linear models thanks to their ability to capture changes in the transmission mechanism of financial shocks between good and bad times. Such models could have sent a credible advance warning ahead of the Great Recession. Furthermore, the discrepancies between models are themselves predictable, which allows the forecaster to formulate reasonable real-time guesses on which model is likely to be more accurate in the next future.

Suggested Citation

  • Piergiorgio Alessandri & Haroon Mumtaz, 2014. "Financial indicators and density forecasts for US output and inflation," Temi di discussione (Economic working papers) 977, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_977_14
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    References listed on IDEAS

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    Cited by:

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    2. Seitz, Franz & Baumann, Ursel & Albuquerque, Bruno, 2015. "The information content of money and credit for US activity," Working Paper Series 1803, European Central Bank.
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    4. Del Negro, Marco & Hasegawa, Raiden B. & Schorfheide, Frank, 2016. "Dynamic prediction pools: An investigation of financial frictions and forecasting performance," Journal of Econometrics, Elsevier, vol. 192(2), pages 391-405.
    5. repec:ecb:ecbwps:20141803 is not listed on IDEAS
    6. Petrella, Ivan & Venditti, Fabrizio & Delle Monache, Davide, 2016. "Adaptive state space models with applications to the business cycle and financial stress," CEPR Discussion Papers 11599, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    financial frictions; predictive densities; Great Recession; Threshold VAR;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises

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