Economic downturn and the yield curve: Evidence from Canada and the US

Libo Xu ()
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Libo Xu: Lakehead University

Journal of Economics and Finance, 2025, vol. 49, issue 2, No 10, 536-567

Abstract: Abstract The paper utilized the Sahm rule recession indicator to examine the relationship between the yield curve shape and recession risk. In doing so, we constructed the recession indicator and estimated a latent factor model that allows a rich interdependence between bond yields and the indicator in Canada and the US. The results based on impulse response functions confirm the predictive power of the yield curve’s slope on the future recession. Moreover, the quantitative analysis also shows that a downward shift in the yield curve and a decline in the yield curve’s curvature indicate a higher recession risk in the future. Forecast error variance decompositions highlighted the contribution of the information, which is extracted from the shape of the yield curve, to the variability in the recession risk in the long run.

Keywords: Yield to maturity; Yield curve; Recession (search for similar items in EconPapers)
JEL-codes: C32 E44 E52 G17 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s12197-025-09716-y

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