Predicting Power of Yield Curve – A Study of Indian Sovereign Yield Spread

Abstract

In recent years, there has been renewed interest in the yield curve as a predictor of future economic activity. In this paper, we re-examine the evidence for this predictor for the Indian market. The paper tries to indicate how the yield curve spread in a government securities market may be used to indicate the future economic activity in an economy like India. The slope of the yield curve has often been considered as a leading economic indicator. The study suggests that the yield curve spread measured by the difference in the spot rates of 10-year and 3 months have predictive power to estimate the economic activity in terms of Index of Industrial production. Using the yield curve data from 1997-2011, the study has found that the yield curve spread can be used to estimate future economic activity.

Keywords: Predicting power of Yield Curve, Indian Yield Curve, Inflation expectation, Recession, Industrial Production, IIP, Yield Spread, Probit Model, Logit Model

JEL Classification: C22, E37, E43