Forecasting Euro-Area Recessions Using Time-Varying Binary Response Models for Financial Markets

30 Pages Posted: 27 Jun 2010

See all articles by Christophe Bellégo

Christophe Bellégo

CREST (Center for Research in Economics and Statistics) - ENSAE (National School for Statistics and Economic Administration)

Laurent Ferrara

Banque de France

Date Written: November 1, 2009

Abstract

Recent macroeconomic evolutions during the years 2008 and 2009 have pointed out the impact of financial markets on economic activity. In this paper, we propose to evaluate the ability of a set of financial variables to forecast recessions in the euro area by using a non-linear binary response model associated with information combination. Especially, we focus on a time-varying probit model whose parameters evolve according to a Markov chain. For various forecast horizons, we provide a readable and leading signal of recession by combining information according to two combining schemes over the sample 1970 - 2006. First we average recession probabilities and second we linearly combine variables through a dynamic factor model in order to estimate an innovative factor augmented probit model. Out-of sample results over the period 2007 - 2008 show that financial variables would have been helpful in predicting a recession signal as early as September 2007, that is around six months before the effective start of the 2008 - 2009 recession in the euro area.

Keywords: Macroeconomic forecasting, Business cycles, Turning points, Financial markets, Non-linear time series, Combining forecasts

JEL Classification: C53, E32, E44

Suggested Citation

Bellégo, Christophe and Ferrara, Laurent, Forecasting Euro-Area Recessions Using Time-Varying Binary Response Models for Financial Markets (November 1, 2009). Banque de France Working Paper No. 259, Available at SSRN: https://ssrn.com/abstract=1630272 or http://dx.doi.org/10.2139/ssrn.1630272

Christophe Bellégo (Contact Author)

CREST (Center for Research in Economics and Statistics) - ENSAE (National School for Statistics and Economic Administration) ( email )

Palaiseau
France

Laurent Ferrara

Banque de France ( email )

Paris
France

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