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Probability and Severity of Recessions

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  • Rachidi Kotchoni
  • Dalibor Stevanovic

Abstract

This paper tackles the prediction of the probability and severity of US recessions. We employ parsimonious Probit models to estimate the probability of a recession h periods ahead, for h varying between 1 and 8 quarters. A novel goodness-of-fit measure derived from the Kullback-Leibler Information Criterion is developed and used to select the regressors to include in the Probit models. Next, an autoregression (AR) augmented with inverse Mills ratio (IMR) and diffusion indices (DI) is fitted to selected measures of real economic activity. The resulting “IMR-DI-AR” model is used to generate forecasts conditional on optimistic and pessimistic scenarios for the horizon of interest. The severity of recessions is defined as the gap between the pessimistic scenario and the recent trend of the series. For a time series of GDP growth, our measure of recession severity has the interpretation of the output loss. Our results support that U.S. recessions are predictable to a great extent, both in terms of occurrence and severity. All recessions are not alike: some are more predictable than others while some are more severe than expected.

Suggested Citation

  • Rachidi Kotchoni & Dalibor Stevanovic, 2013. "Probability and Severity of Recessions," Cahiers de recherche 1341, CIRPEE.
  • Handle: RePEc:lvl:lacicr:1341
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    More about this item

    Keywords

    Forecasting; Principal Components; Probit; Real Activity; Recessions;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models; Discrete Regressors; Proportions
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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