Forecasting Recessions Using the Yield Curve

Abstract

We compare forecasts of recessions using four different specifications of the probit model: a time invariant conditionally independent version; a business cycle specific conditionally independent model; a time invariant probit with autocorrelated errors; and a business cycle specific probit with autocorrelated errors.

The more sophisticated versions of the model take into account some of the potential underlying causes of the documented predictive instability of the yield curve. We find strong evidence in favor of the more sophisticated specification, which allows for multiple break-points across business cycles and autocorrelation. We also develop a new approach to the construction of real time forecasting of recession probabilities.

Keywords: Recession Forecast, Yield Curve, Structural Breaks, Bayesian, Classical Methods

JEL Classification: C2, C11, C53, E3, E4, E52