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Modeling of Economic and Financial Conditions for Nowcasting and Forecasting Recessions: A Unified Approach

Author

Listed:
  • Cem Cakmakli

    () (Koc University)

  • Hamza Demircan

    () (Koc University)

  • Sumru Altug

    () (American University of Beirut, CEPR)

Abstract

In this paper, we propose a method for jointly estimating indexes of economic and financial conditions by exploiting the intertemporal link between their cyclical behavior. This method combines a dynamic factor model for the joint modeling of economic and financial variables with mixed frequencies together with a tailored Markov regime switching specification for capturing their cyclical behavior. It allows for imperfect synchronization between the cycles in economic and financial conditions/factors by explicitly estimating the phase shifts between their cyclical regimes. We examine the efficacy of the model for predicting cyclical activity in a key emerging economy, namely, Turkey, by making use of a mixed frequency ragged-edge data set. A comparison of our framework with more conventional cases imposing common cyclical dynamics as well as independent cyclical dynamics for the economic and financial indicators reveals that the proposed specification provides precise estimates of indexes of economic and financial activity together with accurate and timely recession probabilities. Recession probabilities estimated using the available data in the first week of November 2018 indicate that Turkey entered a recession that is still ongoing starting from August 2018. We further conduct a recursive real-time exercise of nowcasting and forecasting business cycle turning points. The results show evidence for the superior predictive power of our specification by signaling oncoming recessions (expansions) as early as 3.6 (3.3) months ahead of the actual realization.

Suggested Citation

  • Cem Cakmakli & Hamza Demircan & Sumru Altug, 2019. "Modeling of Economic and Financial Conditions for Nowcasting and Forecasting Recessions: A Unified Approach," Koç University-TUSIAD Economic Research Forum Working Papers 1907, Koc University-TUSIAD Economic Research Forum.
  • Handle: RePEc:koc:wpaper:1907
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    Keywords

    Financial conditions index; Coincident economic index; Dynamic factor model; Markov switching; Imperfect synchronization; Bayesian inference.;

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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