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Credit Spreads as Predictors of Real-Time Economic Activity: A Bayesian Model-Averaging Approach

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  • Jon Faust
  • Simon Gilchrist
  • Jonathan H. Wright
  • Egon Zakrajsek

Abstract

Employing a large number of real and financial indicators, we use Bayesian Model Averaging (BMA) to forecast real-time measures of economic activity. Importantly, the predictor set includes option-adjusted credit spread indexes based on bond portfolios sorted by maturity and credit risk as measured by the issuer’s “distance-to-default.” The portfolios are constructed directly from the secondary market prices of outstanding senior unsecured bonds issued by a large number of U.S. corporations. Our results indicate that relative to an autoregressive benchmark, BMA yields consistent improvements in the prediction of the growth rates of real GDP, business fixed investment, industrial production, and employment, as well as of the changes in the unemployment rate, at horizons from the current quarter (i.e., “nowcasting”) out to four quarters hence. The gains in forecast accuracy are statistically significant and economically important and owe exclusively to the inclusion of our portfolio credit spreads in the set of predictors—BMA consistently assigns a high posterior weight to models that include these financial indicators.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16725.

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Date of creation: Jan 2011
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Publication status: published as Jon Faust & Simon Gilchrist & Jonathan H. Wright & Egon Zakrajšsek, 2013. "Credit Spreads as Predictors of Real-Time Economic Activity: A Bayesian Model-Averaging Approach," The Review of Economics and Statistics, MIT Press, vol. 95(5), pages 1501-1519, December.
Handle: RePEc:nbr:nberwo:16725

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  1. Sreedhar T. Bharath & Tyler Shumway, 2008. "Forecasting Default with the Merton Distance to Default Model," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 21(3), pages 1339-1369, May.
  2. Jonah B. Gelbach & Doug Miller, 2009. "Robust Inference with Multi-way Clustering," Working Papers, University of California, Davis, Department of Economics 99, University of California, Davis, Department of Economics.
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As found on the RePEc Biblio, the curated bibliography for Economics:
  1. > Econometrics > Forecasting > Forecasting Economic Activity Using Financial Variables
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Cited by:
  1. Leroi Raputsoane, 2014. "Disaggregated Credit Extension and Financial Distress in South Africa," Working Papers, Economic Research Southern Africa 435, Economic Research Southern Africa.
  2. John V. Duca, 2011. "Did the commercial paper funding facility prevent a Great Depression-style money market meltdown?," Working Papers, Federal Reserve Bank of Dallas 1101, Federal Reserve Bank of Dallas.
  3. Simon Gilchrist & Egon Zakrajsek, 2012. "Credit Spreads and Business Cycle Fluctuations," American Economic Review, American Economic Association, American Economic Association, vol. 102(4), pages 1692-1720, June.
  4. Liebermann, Joelle, 2012. "Real-time forecasting in a data-rich environment," MPRA Paper 39452, University Library of Munich, Germany.
  5. Breitung, Jörg & Eickmeier, Sandra, 2014. "Analyzing business and financial cycles using multi-level factor models," Discussion Papers, Deutsche Bundesbank, Research Centre 11/2014, Deutsche Bundesbank, Research Centre.
  6. Eickmeier, Sandra & Marcellino, Massimiliano & Prieto, Esteban, 2013. "Time Variation in Macro-Financial Linkages," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9436, C.E.P.R. Discussion Papers.
  7. Hännikäinen, Jari, 2014. "Zero lower bound, unconventional monetary policy and indicator properties of interest rate spreads," MPRA Paper 56737, University Library of Munich, Germany.
  8. Jon D. Samuels & Rodrigo Sekkel, 2013. "Forecasting with Many Models: Model Confidence Sets and Forecast Combination," Working Papers, Bank of Canada 13-11, Bank of Canada.
  9. Peter Broer & Jürgen Antony, 2013. "Financial Shocks and Economic Activity in the Netherlands," CPB Discussion Paper, CPB Netherlands Bureau for Economic Policy Analysis 260, CPB Netherlands Bureau for Economic Policy Analysis.
  10. William F. Bassett & Mary Beth Chosak & John C. Driscoll & Egon Zakrajsek, 2012. "Changes in bank lending standards and the macroeconomy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2012-24, Board of Governors of the Federal Reserve System (U.S.).

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