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Predicting European Union recessions in the euro era: The yield curve as a forecasting tool of economic activity

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  • Gogas, Periklis
  • Chionis, Dionisios
  • Pragkidis, Ioannis

Abstract

Several studies have established the predictive power of the yield curve, ie: the difference between long and short term bond rates, in terms of real economic activity, for the U.S. and various European countries. In this paper we use data from the European Union (EU15), ranging from 1994:Q1 to 2008:Q3. The seasonally adjusted real GDP is used to extract the long run trend and the cyclical component of the European output, while the European Central Bank’s euro area government benchmark bonds of various maturities are used for the calculation of the yield spreads. We also augment the models tested with non monetary policy variables: the unemployment and a composite European stock price index constructed from the indices of the three major European stock markets of London, Frankfurt and Paris. The methodology employed in the effort to forecast recessions, is a probit model of the inverse cumulative distribution function of the standard distribution, using several formal forecasting evaluation tests. The results show that the yield curve augmented with the composite stock index has significant forecasting power in terms of the EU15 real output.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 13911.

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Date of creation: Mar 2009
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Handle: RePEc:pra:mprapa:13911

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Keywords: forecasting; yield spread; recession; probit; term structure; monetary policy; real growth;

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  1. Andrew Ang & Monika Piazzesi & Min Wei, 2004. "What Does the Yield Curve Tell us about GDP Growth?," NBER Working Papers 10672, National Bureau of Economic Research, Inc.
  2. Estrella, Arturo & Hardouvelis, Gikas A, 1991. " The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-76, June.
  3. Marcelle Chauvet & Simon Potter, 2001. "Forecasting recessions using the yield curve," Staff Reports 134, Federal Reserve Bank of New York.
  4. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Arturo Estrella & Anthony P. Rodrigues & Sebastian Schich, 2000. "How stable is the predictive power of the yield curve? evidence from Germany and the United States," Staff Reports 113, Federal Reserve Bank of New York.
  6. Mateus A. Feitosa & Benjamin M. Tabak, 2007. "Predictability Of Economic Activity Using Yield Spreads: The Case Of Brazil," Anais do XXXV Encontro Nacional de Economia [Proceedings of the 35th Brazilian Economics Meeting] 029, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  7. Estrella, Arturo & Mishkin, Frederic S., 1997. "The predictive power of the term structure of interest rates in Europe and the United States: Implications for the European Central Bank," European Economic Review, Elsevier, vol. 41(7), pages 1375-1401, July.
  8. Hamilton, James Douglas & Kim, Dong Heon, 2000. "A Re-examination of the Predictability of Economic Activity Using the Yield Spread," University of California at San Diego, Economics Working Paper Series qt69v8p1m9, Department of Economics, UC San Diego.
  9. Kim, Kenneth A. & Limpaphayom, Piman, 1997. "The effect of economic regimes on the relation between term structure and real activity in Japan," Journal of Economics and Business, Elsevier, vol. 49(4), pages 379-392.
  10. Jonathan H. Wright, 2006. "The yield curve and predicting recessions," Finance and Economics Discussion Series 2006-07, Board of Governors of the Federal Reserve System (U.S.).
  11. Venetis, Ioannis A. & Paya, Ivan & Peel, David A., 2003. "Re-examination of the predictability of economic activity using the yield spread: a nonlinear approach," International Review of Economics & Finance, Elsevier, vol. 12(2), pages 187-206.
  12. Cogley, Timothy & Nason, James M., 1995. "Effects of the Hodrick-Prescott filter on trend and difference stationary time series Implications for business cycle research," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 253-278.
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Cited by:
  1. Kuosmanen, Petri & Vataja, Juuso, 2014. "Forecasting GDP growth with financial market data in Finland: Revisiting stylized facts in a small open economy during the financial crisis," Review of Financial Economics, Elsevier, vol. 23(2), pages 90-97.
  2. Periklis Gogas & Ioannis Pragidis, 2010. "GDP Trend Deviations and the Yield Spread: the Case of Five E.U. Countries," Papers 1005.1326, arXiv.org.
  3. Periklis Gogas & Ioannis Pragidis, 2012. "GDP trend deviations and the yield spread: the case of eight E.U. countries," Journal of Economics and Finance, Springer, vol. 36(1), pages 226-237, January.

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