Assessing Macroeconomic Tail Risks in a Data-Rich Environment

42 Pages Posted: 2 Dec 2019

See all articles by Thomas R. Cook

Thomas R. Cook

Federal Reserve Bank of Kansas City

Taeyoung Doh

Federal Reserve Bank of Kansas City

Date Written: November 20, 2019

Abstract

We use a large set of economic and financial indicators to assess tail risks of the three macroeconomic variables: real GDP, unemployment, and inflation. When applied to U.S. data, we find evidence that a dense model using principal components (PC) as predictors might be misspecified by imposing the “common slope” assumption on the set of predictors across multiple quantiles. The common slope assumption ignores the heterogeneous informativeness of individual predictors on different quantiles. However, the parsimony of the PC-based approach improves the accuracy of out-of-sample forecasts when combined with a sparse model using the dynamic model averaging method. Out-of-sample analysis of U.S. data suggests that the downside risk for real macro variables spiked to by the end of the Great Recession but subsequently declined to a negligible level. On the other hand, the downside tail risk for inflation fluctuated around a non-negligible level even after the end of the Great Recession. The disconnect between the downside risk of inflation and that of real activities can be in line with the evidence for the reduced role of the output gap for inflation during the recent period.

Keywords: Quantile Regressions; Tail Risks; Variable Selection; Dynamic Model Averaging

JEL Classification: C22, C55, E27, E37

Suggested Citation

Cook, Thomas R. and Doh, Taeyoung, Assessing Macroeconomic Tail Risks in a Data-Rich Environment (November 20, 2019). Federal Reserve Bank of Kansas City Working Paper RWP 19-12, November 2019, Available at SSRN: https://ssrn.com/abstract=3494412 or http://dx.doi.org/10.2139/ssrn.3494412

Thomas R. Cook (Contact Author)

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

Taeyoung Doh

Federal Reserve Bank of Kansas City ( email )

1 Memorial Dr.
Kansas City, MO 64198
United States

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