Yields_recession

Yields_recession - Finance and Economics Discussion Series...

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Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C. The Yield Curve and Predicting Recessions Jonathan H. Wright 2006-07 NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the Finance and Economics Discussion Series (other than acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers.
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The Yield Curve and Predicting Recessions Jonathan H. Wright * Federal Reserve Board, Washington DC February 2006 Abstract : The slope of the Treasury yield curve has often been cited as a leading economic indicator, with inversion of the curve being thought of as a harbinger of a recession. In this paper, I consider a number of probit models using the yield curve to forecast recessions. Models that use both the level of the federal funds rate and the term spread give better in- sample fit, and better out-of-sample predictive performance, than models with the term spread alone. There is some evidence that controlling for a term premium proxy as well may also help. I discuss the implications of the current shape of the yield curve in the light of these results, and report results of some tests for structural stability and an evaluation of out-of-sample predictive performance. JEL Classification: C22, E37, E43 Keywords : Interest Rates, Forecasting, GDP Growth, Term Premiums, Probit. * Division of Monetary Affairs, Federal Reserve Board, Washington DC 20551. I am grateful to Mary Zaki for excellent research assistance and to Andy Levin and Jennifer Roush for helpful comments. All remaining errors are my own. The views expressed in this paper are solely the responsibility of the author and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other employee of the Federal Reserve System. Email addresses for the author is [email protected]
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1. Introduction The slope of the Treasury yield curve has often been cited as a leading economic indicator, with inversion of the curve being thought of as a harbinger of a recession. Of course, growth, recessions, and interest rates are all endogenous and any association among them is purely a reduced form correlation. However, historically, the three-month less ten-year term spread has exhibited a negative statistical relationship with real GDP growth over subsequent quarters, and a positive statistical relationship with the odds of a recession (see, for example, Estrella and Hardouvelis (1991) and Estrella and Mishkin (1996, 1998) and the references therein). The same is true for other similar measures of the difference between short- and long-term interest rates. The term spread is an important part of several
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This note was uploaded on 02/29/2012 for the course EC 513 taught by Professor Staff during the Fall '08 term at Alabama.

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Yields_recession - Finance and Economics Discussion Series...

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