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Markov Switching with Endogenous Number of Regimes and Leading Indicators in a Real-Time Business Cycle Forecast

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  • Theobald, Thomas

Abstract

This paper uses several macroeconomic and financial indicators within a Markov Switching (MS) framework to predict the turning points of the business cycle. The presented model is applied to monthly German real-time data covering the recession and the recovery after the financial crisis. We show how to take advantage of combining single MSARX forecasts with the adjusting of the number of regimes on the real-time path, which both lead to higher forecast accuracy through the non-linearity of the underlying data-generating process. Adjusting the number of regimes implies distinguishing between recessions which are either normal or extraordinary, i.e. specifically determining as early as possible the point in time from which the recession in the aftermath of the financial crisis structurally exceeded previous ones. In fact it turns out that the Markov Switching model can signal quite early whether a conventional recession will occur or whether an economic downturn will be more pronounced.

Suggested Citation

  • Theobald, Thomas, 2013. "Markov Switching with Endogenous Number of Regimes and Leading Indicators in a Real-Time Business Cycle Forecast," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79911, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc13:79911
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    JEL classification:

    • C24 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Truncated and Censored Models; Switching Regression Models; Threshold Regression Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications

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