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Financial Market Perceptions of Recession Risk

22 Pages Posted: 4 Dec 2007  

Thomas B. King

Federal Reserve Bank of Chicago

Andrew T. Levin

affiliation not provided to SSRN

Roberto Perli

Federal Reserve Board - Monetary Affairs

Date Written: October 2007

Abstract

Over the Great Moderation period in the United States, we find that corporate credit spreads embed crucial information about the one-year-ahead probability of recession, as evidenced by both in-and out-of-sample fit. Furthermore, the incidence of false positive predictions of recession is dramatically reduced by utilizing a bivariate model that includes a measure of credit spreads along with the slope of the yield curve; indeed, these bivariate models provide much better forecasting performance than any combination of univariate models. We also find that optimal (Bayesian) model combination strongly dominates simple averaging of model forecasts in predicting recessions.

Keywords: Recession forecasting, yield curve, term spread, credit spread

JEL Classification: E37, E44

Suggested Citation

King, Thomas B. and Levin, Andrew T. and Perli, Roberto, Financial Market Perceptions of Recession Risk (October 2007). FEDS Working Paper No. 2007-57. Available at SSRN: https://ssrn.com/abstract=1049081 or http://dx.doi.org/10.2139/ssrn.1049081

Thomas B. King

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

Andrew Levin (Contact Author)

affiliation not provided to SSRN

Roberto Perli

Federal Reserve Board - Monetary Affairs ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2465 (Phone)
202-452-2301 (Fax)

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