Does the Yield Spread Retain its Forecasting Ability During the 2007 Recession? A Comparative Analysis

Abstract

Spread’s predictive ability is reviewed by implementing a number of linear and probit models. We conduct a comparative analysis of the forecasting performance of various specifications by focusing on the last three major US economic slowdowns. The results indicate that although linear models are useful in predicting the 1990 and 2001 decline in economic activity, none of these give signal of the 2007 decline in GDP. We find evidence that there is more information in the shape of the yield curve about the future economic activity than that provided by only the spread. We document that probit models are doing well in signalling the onset of 2007 crisis although they fail to capture its duration.

Keywords: C35, E43, E52

JEL Classification: Yield spread, Business cycles, Probit models