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

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

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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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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  1. 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.).
  2. 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.
  3. Marcelle Chauvet & Simon Potter, 2001. "Forecasting recessions using the yield curve," Staff Reports 134, Federal Reserve Bank of New York.
  4. Hodrick, Robert J & Prescott, Edward C, 1997. "Postwar U.S. Business Cycles: An Empirical Investigation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 1-16, February.
  5. Andrew Ang & Monika Piazzesi & Min Wei, 2003. "What does the yield curve tell us about GDP growth?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  6. 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.
  7. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
  8. 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].
  9. 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.
  10. 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.
  11. Hamilton, James D & Kim, Dong Heon, 2002. "A Reexamination of the Predictability of Economic Activity Using the Yield Spread," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 340-60, May.
  12. 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.
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