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

  • Chauvet, Marcelle
  • Senyuz, Zeynep

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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File URL: http://mpra.ub.uni-muenchen.de/15076/1/MPRA_paper_15076.pdf
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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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  23. Jushan Bai, 1995. "Estimating Multiple Breaks One at a Time," Working papers 95-18, Massachusetts Institute of Technology (MIT), Department of Economics.
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