Measuring and Predicting Heterogeneous Recessions

Tinbergen Institute Discussion Paper No. 2011-154/4

59 Pages Posted: 3 Nov 2011

See all articles by Cem Cakmakli

Cem Cakmakli

affiliation not provided to SSRN

Richard Paap

Erasmus University Rotterdam (EUR) - Department of Econometrics; Tinbergen Institute; Erasmus Research Institute of Management (ERIM)

Dick J. C. van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM

Date Written: October 31, 2011

Abstract

This paper examines whether the Conference Board's Leading Economic Index (LEI) can be used for modeling and forecasting a more refined business cycle classification beyond the usual distinction between expansions and contractions. Univariate Markov-switching models for monthly coincident variables and the LEI show that a three regime model is more appropriate than a model with only two regimes. Interestingly, the third regime captures 'severe recessions' contrasting the conventional view that the additional third regime represents a 'recovery' phase. This is confirmed by means of Markov-switching vector autoregressive models that allow for phase shifts between the cyclical regimes of LEI and industrial production. Results indicate that a three regime model with a severe recession phase describes the cyclical dynamics in these series better than a two regime model (with only recession and expansion regimes) and a three regime model with a recovery phase. The timing of the third regime mostly corresponds with periods of substantial credit squeezes and dramatic increases in the default spread as in the recent recession of 2007-2009. These findings provide empirical evidence for the theory of 'financial accelerator'. The severe recession regime of the LEI leads that of IP by 6.5 months whereas for mild recessions this lead time increases to one year.

Keywords: Business cycle, phase shifts, regime-switching models, Bayesian analysis

JEL Classification: C11, C32, C51, C52, E32

Suggested Citation

Cakmakli, Cem and Paap, Richard and van Dijk, Dick J.C., Measuring and Predicting Heterogeneous Recessions (October 31, 2011). Tinbergen Institute Discussion Paper No. 2011-154/4. Available at SSRN: https://ssrn.com/abstract=1953871 or http://dx.doi.org/10.2139/ssrn.1953871

Cem Cakmakli (Contact Author)

affiliation not provided to SSRN

Richard Paap

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Dick J.C. Van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1263 (Phone)
+31 10 4089162 (Fax)

HOME PAGE: http://people.few.eur.nl/djvandijk

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