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

46 Pages Posted: 7 May 2009

See all articles by Marcelle Chauvet

Marcelle Chauvet

University of California Riverside

Zeynep Senyuz

Board of Governors of the Federal Reserve System

Date Written: April 2009

Abstract

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.

Keywords: Forecasting, Business Cycles, Yield Curve, Dynamic Factor Models, Markov Switching

JEL Classification: C32, E32, E44

Suggested Citation

Chauvet, Marcelle and Senyuz, Zeynep, A Joint Dynamic Bi-Factor Model of the Yield Curve and the Economy as a Predictor of Business Cycles (April 2009). Available at SSRN: https://ssrn.com/abstract=1400429 or http://dx.doi.org/10.2139/ssrn.1400429

Marcelle Chauvet (Contact Author)

University of California Riverside ( email )

900 University Avenue
4136 Sproul Hall
Riverside, CA 92521
United States
(951) 827-1587 (Phone)

HOME PAGE: http://https://sites.google.com/site/marcellechauvet/

Zeynep Senyuz

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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