Improving the Predictive Power of Spreads for Economic Activity: A Wavelet Method

Chang Min Lee () and Hahn Lee ()
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Chang Min Lee: Financial Market Analysis Division, Financial Services Commission, Korea.

Journal for Economic Forecasting, 2016, issue 4, 65-78

Abstract: In this paper, we examine whether and to what extent the predictive power of credit spread for real economic activity can be enhanced by using additional information via wavelet approach. In doing so, we first apply the wavelet analysis to the Korean real GDP data, and present evidence that the business-cycle component of wavelet-filtered series closely resembles the series obtained from an approximate band-pass filter. Given the recent empirical findings that the credit spread has a useful explanatory power for future economic fluctuations, we also suggest that the business-cycle component of the credit spread can better predict the probability of a recession than the usual time- domain analysis. The wavelet methodology used in this paper can naturally be applied to any sets of economic and financial time series to unveil their structures and hence to enhance their predictive contents.

Keywords: credit spread; business cycle; wavelet decomposition (search for similar items in EconPapers)
JEL-codes: C25 E32 E43 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (6)

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