Yield-Curve Based Probit Models for Forecasting U.S. Recessions: Stability and Dynamics

Recent research provides controversial evidence on the stability of yield-curve based binary probit models for forecasting U.S. recessions. This paper reviews so far applied specifications and presents new procedures for examining the stability of selected probit models. It finds that a yield-curve based probit model that treats the binary response (a recession dummy) as a nonhomogeneous Markov chain produces superior in-sample and out-of-sample probability forecasts for U.S. recessions and that this model specification is stable over time. Thus, the failure of yieldcurve based forecasts to signal the 1990-1991 and 2001 recessions should not be attributed to parameter instability, instead the evidence suggests that these events were inherently uncertain.

[1]  W. Newey,et al.  Automatic Lag Selection in Covariance Matrix Estimation , 1994 .

[2]  D. Andrews.  Tests for Parameter Instability and Structural Change with Unknown Change Point , 1993 .

[3]  Ludwig Fahrmeir,et al.  REGRESSION MODELS FOR NON‐STATIONARY CATEGORICAL TIME SERIES , 1987 .

[4]  G. Schwarz.  Estimating the Dimension of a Model , 1978 .

[5]  H. Kaufmann,et al.  Regression Models for Nonstationary Categorical Time Series: Asymptotic Estimation Theory , 1987 .

[6]  Benjamin Kedem,et al.  Prediction and Classification of Non-stationary Categorical Time Series , 1998 .

[7]  Margaret Mary McConnell,et al.  Output Fluctuations in the United States: What Has Changed Since the Early 1980s? , 1998 .

[8]  Marcelle Chauvet,et al.  A Comparison of the Real-Time Performance of Business Cycle Dating Methods , 2005 .

[9]  Arturo Estrella,et al.  How Stable is the Predictive Power of the Yield Curve? Evidence from Germany and the United States , 2000 .

[10]  E. Slud,et al.  Binary Time Series , 1980 .

[11]  Arturo Estrella,et al.  A new measure of fit for equations with dichotomous dependent variables , 1998 .

[12]  Marcelle Chauvet,et al.  Forecasting Recessions Using the Yield Curve , 2001 .

[13]  Arturo Estrella,et al.  The Yield Curve as a Leading Indicator: Some Practical Issues , 2006 .

[14]  Adrian Pagan,et al.  A comparison of two business cycle dating methods , 2003 .

[15]  Lutz Kilian,et al.  On the Selection of Forecasting Models , 2003, SSRN Electronic Journal.

[16]  J. Monahan.  A note on enforcing stationarity in autoregressive-moving average models , 1984 .

[17]  O. Barndorff-Nielsen,et al.  On the parametrization of autoregressive models by partial autocorrelations , 1973 .

[18]  Neil Shephard,et al.  Dynamics of Trade-by-Trade Price Movements: Decomposition and Models , 1999 .

[19]  Arturo Estrella,et al.  The term structure as a predictor of real economic activity , 1991 .

[20]  D. Andrews.  Tests for Parameter Instability and Structural Change with Unknown Change Point , 1993 .

[21]  Donald W. K. Andrews,et al.  Inference in Nonlinear Econometric Models with Structural Change , 1988 .

[22]  Predicting A Recession: Evidence From The Yield Curve In The Presence Of Structural Breaks , 2002 .

[23]  A. Estrella.  CRITICAL VALUES AND P VALUES OF BESSEL PROCESS DISTRIBUTIONS: COMPUTATION AND APPLICATION TO STRUCTURAL BREAK TESTS , 2003, Econometric Theory.

[24]  Daniel M. Keenan,et al.  A Time Series Analysis of Binary Data , 1982 .

[25]  Frederic S. Mishkin,et al.  Predicting U.S. Recessions: Financial Variables as Leading Indicators , 1995, Review of Economics and Statistics.