What Does the Yield Curve Tell Us About GDP Growth?
40 Pages Posted: 23 Jan 2005
Date Written: March 24, 2003
A lot, including a few things you may not expect. Previous studies find that the term spread forecasts GDP but these regressions are unconstrained and do not model regressor endogeneity. We build a dynamic model for GDP growth and yields that completely characterizes expectations of GDP. The model does not permit arbitrage. Contrary to previous findings, we predict that the short rate has more predictive power than any term spread. We confirm this finding by forecasting GDP out-of-sample. The model also recommends the use of lagged GDP and the longest maturity yield to measure slope. Greater efficiency enables the yield-curve model to produce superior out-of-sample GDP forecasts than unconstrained OLS at all horizons.
Keywords: GDP Forecasting; Short Rate; Term Spread; Arbitrage-Free Term Structure Models; Out-of-Sample Forecast
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