Predicting Recessions: Financial Cycle versus Term Spread

29 Pages Posted: 14 Oct 2019

See all articles by Claudio E. V. Borio

Claudio E. V. Borio

Bank for International Settlements (BIS) - Research and Policy Analysis

Mathias Drehmann

Bank for International Settlements (BIS)

Fan Dora Xia

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: October 11, 2019

Abstract

Financial cycles can be important drivers of real activity, but there is scant evidence about how well they signal recession risks. We run a horse race between the term spread - the most widely used indicator in the literature - and a range of financial cycle measures. Unlike most papers, ours assesses forecasting performance not just for the United States but also for a panel of advanced and emerging market economies. We find that financial cycle measures have significant forecasting power both in and out of sample, even for a three-year horizon. Moreover, they outperform the term spread in nearly all specifications. These results are robust to different recession specifications.

Keywords: financial cycle, term spread, recession risk, panel probit mode

JEL Classification: C33, E37, E44

Suggested Citation

Borio, Claudio E.V. and Drehmann, Mathias and Xia, Fan Dora, Predicting Recessions: Financial Cycle versus Term Spread (October 11, 2019). BIS Working Paper No. 818, Available at SSRN: https://ssrn.com/abstract=3468418

Claudio E.V. Borio (Contact Author)

Bank for International Settlements (BIS) - Research and Policy Analysis ( email )

CH-4002 Basel, Basel-Stadt
Switzerland

Mathias Drehmann

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Fan Dora Xia

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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