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Real-time Markov Switching and Leading Indicators in Times of the Financial Crisis

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  • Thomas Theobald

Abstract

This paper uses several macroeconomic and financial indicators within a Markov Switching (MS) framework to predict the turning points of the business cycle. The presented model is applied to monthly German real-time data covering the recession and the recovery after the financial crisis. We show how to take advantage of combining single MS forecasts and of changing the number of regimes on the real-time path, where both leads to a higher forecast accuracy. Changing the number of regimes implies a distinction for recessions representing either a normal or an extraordinary one, which particularly means to determine as early as possible the point in time, from which the last recession structurally exceeded the previous ones. In fact it turns out that the Markov Switching model can signal quite early whether a conventional recession happens or whether an economic downturn will be more substantial.

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File URL: http://www.boeckler.de/pdf/p_imk_wp_98_2012.pdf
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Bibliographic Info

Paper provided by IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute in its series IMK Working Paper with number 98-2012.

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Length: 34 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:imk:wpaper:98-2012

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Related research

Keywords: Business Cycle; Leading Indicators; Macroeconomic Forecasting; Markov Switching;

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References

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  1. Kim, Chang-Jin, 1994. "Dynamic linear models with Markov-switching," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 1-22.
  2. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
  3. Marcelle Chauvet & Simon Potter, 2001. "Forecasting recessions using the yield curve," Staff Reports 134, Federal Reserve Bank of New York.
  4. Gilchrist, Simon & Yankov, Vladimir & Zakrajsek, Egon, 2009. "Credit market shocks and economic fluctuations: Evidence from corporate bond and stock markets," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 471-493, May.
  5. Don Harding & Adrian Pagan, 2000. "Disecting the Cycle: A Methodological Investigation," Econometric Society World Congress 2000 Contributed Papers 1164, Econometric Society.
  6. Garcia, Rene, 1998. "Asymptotic Null Distribution of the Likelihood Ratio Test in Markov Switching Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 763-88, August.
  7. Friedman, Benjamin M & Kuttner, Kenneth N, 1992. "Money, Income, Prices, and Interest Rates," American Economic Review, American Economic Association, vol. 82(3), pages 472-92, June.
  8. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
  9. Hansen, Bruce E, 1996. "Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis," Econometrica, Econometric Society, vol. 64(2), pages 413-30, March.
  10. James D. Hamilton, 2010. "Calling Recessions in Real Time," NBER Working Papers 16162, National Bureau of Economic Research, Inc.
  11. Beate Schirwitz, 2009. "A comprehensive German business cycle chronology," Empirical Economics, Springer, vol. 37(2), pages 287-301, October.
  12. Robert Breunig & Serinah Najarian & Adrian Pagan, 2003. "Specification Testing of Markov Switching Models," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(s1), pages 703-725, December.
  13. Meeks, Roland, 2012. "Do credit market shocks drive output fluctuations? Evidence from corporate spreads and defaults," Journal of Economic Dynamics and Control, Elsevier, vol. 36(4), pages 568-584.
  14. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  15. Gad Levanon, 2010. "Evaluating and Comparing Leading and Coincident Economic Indicators," Business Economics, Palgrave Macmillan, vol. 45(1), pages 16-27, January.
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