A Dynamic Factor Model of the Yield Curve as a Predictor of the Economy

45 Pages Posted: 27 Jun 2012

See all articles by Marcelle Chauvet

Marcelle Chauvet

University of California Riverside

Zeynep Senyuz

Board of Governors of the Federal Reserve System

Date Written: March 1, 2012

Abstract

In this paper, we propose 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 future economic growth as well as the beginning and end of economic recessions at the monthly frequency. The proposed nonlinear multivariate dynamic factor model takes into account not only the popular term spread but also information extracted from the level and curvature of the yield curve and from macroeconomic variables. 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. The proposed factor model of the yield curve exhibits substantial incremental predictive value compared to several alternative specifications. This result holds in-sample and out-of-sample, using revised or real time unrevised data.

Keywords: Forecasting, business cycles, dynamic factor models, Markov switching

JEL Classification: C32, E32, E44

Suggested Citation

Chauvet, Marcelle and Senyuz, Zeynep, A Dynamic Factor Model of the Yield Curve as a Predictor of the Economy (March 1, 2012). FEDS Working Paper No. 2012-32. Available at SSRN: https://ssrn.com/abstract=2093357 or http://dx.doi.org/10.2139/ssrn.2093357

Marcelle Chauvet

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 (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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

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