Understanding Growth-at-Risk: A Markov Switching Approach

72 Pages Posted: 25 Feb 2022

See all articles by Dario Caldara

Dario Caldara

Board of Governors of the Federal Reserve System

Danilo Cascaldi-Garcia

Board of Governors of the Federal Reserve System

Pablo Cuba-Borda

Board of Governors of the Federal Reserve System

Francesca Loria

Board of Governors of the Federal Reserve System

Date Written: January 2021

Abstract

Both financial and macroeconomic conditions matter for downside risks to the economic outlook. In this paper, we show that the deterioration of the financial and real sides dramatically increase the probability of tail risks of large negative growth over the next year. We propose a real-time measure of financial conditions and economic activity for the United States, and use these measures to construct conditional quantiles and predictive distributions of average GDP growth over the next 12 months. We find that periods of high macro and financial distress, such as the Global Financial Crisis and the COVID-19 pandemic, are associated with a low average future growth, high uncertainty, and risks tilted to the downside. This methodology is a powerful tool to assess the risk of tail events, such as recessions, and to evaluate the likelihood of point forecasts.

Keywords: Growth-at-Risk, regime-switching regression, quantile regression

JEL Classification: C53, E23, E27, E32, E44

Suggested Citation

Caldara, Dario and Cascaldi-Garcia, Danilo and Cuba-Borda, Pablo and Loria, Francesca, Understanding Growth-at-Risk: A Markov Switching Approach (January 2021). Available at SSRN: https://ssrn.com/abstract=3992793 or http://dx.doi.org/10.2139/ssrn.3992793

Dario Caldara

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Danilo Cascaldi-Garcia

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Pablo Cuba-Borda

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Francesca Loria (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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