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Predicting recessions with leading indicators: An application on the Icelandic economy

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  • Bruno Eklund

Abstract

This paper focuses on the Stock and Watson methodology to fore- cast the future state of the business cycle in the Icelandic economy. By selecting variables available on a monthly basis that mimic the cyclical behaviour of the quarterly GDP, coincident and leading vari- ables are identi?ed. A factor model is then speci?ed based on the assumption that a single common unobservable element drives the cyclical evolution of many of the Icelandic macroeconomic variables. The model is cast into a state space form providing a simple frame- work both for estimation and for predicting the future recession and expansion patterns. Based on the bootstrap resampling technique, a simple approach to estimate recession and expansion probabilities is developed. This method is completely nonparametric compared to the semi-parametric approach used by Stock and Watson.

Suggested Citation

  • Bruno Eklund, 2007. "Predicting recessions with leading indicators: An application on the Icelandic economy," Economics wp33_bruno, Department of Economics, Central bank of Iceland.
    • Handle: RePEc:ice:wpaper:wp33_bruno
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