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A Joint Dynamic Bi-Factor Model of the Yield Curve and the Economy as a Predictor of Business Cycles

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  • Chauvet, Marcelle
  • Senyuz, Zeynep

Abstract

This paper proposes an econometric model of the joint dynamic relationship between the yield curve and the economy to predict business cycles. We examine the predictive value of the yield curve to forecast both future economic growth as well as the beginning and end of economic recessions at the monthly frequency. The proposed multivariate dynamic factor model takes into account not only the popular term spread but also information extracted from the entire yield curve. The nonlinear model is used to investigate the interrelationship between the phases of the bond market and of the business cycle. The results indicate a strong interrelation between these two sectors. Although the popular term spread has a reasonable forecasting performance, the proposed factor model of the yield curve exhibits substantial incremental predictive value. This result holds in-sample and out-of-sample, using revised or real time unrevised data.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 15076.

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Date of creation: Dec 2008
Date of revision: Apr 2009
Handle: RePEc:pra:mprapa:15076

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Keywords: Forecasting; Business Cycles; Yield Curve; Dynamic Factor Models; Markov Switching.;

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References

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  1. Michael Dotsey, 1998. "The predictive content of the interest rate term spread for future economic growth," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 31-51.
  2. Marcelle Chauvet & Simon Potter, 2005. "Forecasting recessions using the yield curve," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 24(2), pages 77-103.
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  18. Bernadell, Carlos & Coche, Joachim & Nyholm, Ken, 2005. "Yield curve prediction for the strategic investor," Working Paper Series 0472, European Central Bank.
  19. Ken Nyholm, 2007. "A New Approach to Predicting Recessions," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 36(1), pages 27-42, 02.
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Cited by:
  1. Christopher J. Neely & David E. Rapach & Jun Tu & Guofu Zhou, 2010. "Out-of-sample equity premium prediction: economic fundamentals vs. moving-average rules," Working Papers 2010-008, Federal Reserve Bank of St. Louis.

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