A New Approach to Predicting Recessions

Ken Nyholm

Economic Notes, 2007, vol. 36, issue 1, 27-42

Abstract: This paper presents a new approach to recession prediction. The methodology relies on the shape of the yield curve alone and does not incorporate macroeconomic information or other explanatory variables. This makes the modelling framework less data intensive and more intuitive than other models that have the same goal. The workhorses of the approach are (i) data transformation of observed yields with the purpose of normalizing the yield spread, and (ii) a three‐state regime‐switching version of the Nelson–Siegel parametric model of the yield curves' shape and location. In an out‐of‐sample exercise the model predicts all US NBER recessions from 1973 to 2004 at least eight months in advance of their occurrences.

Date: 2007
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