A Joint Dynamic Bi-Factor Model of the Yield Curve and the Economy as a Predictor of Business Cycles

Marcelle Chauvet and Zeynep Senyuz

MPRA Paper from University Library of Munich, Germany

Abstract: This paper proposes an econometric model of the joint dynamic relationship between the yield curve and the economy to predict business cycles. We examine the predictive value of the yield curve to forecast both future economic growth as well as the beginning and end of economic recessions at the monthly frequency. The proposed multivariate dynamic factor model takes into account not only the popular term spread but also information extracted from the entire yield curve. The nonlinear model is used to investigate the interrelationship between the phases of the bond market and of the business cycle. The results indicate a strong interrelation between these two sectors. Although the popular term spread has a reasonable forecasting performance, the proposed factor model of the yield curve exhibits substantial incremental predictive value. This result holds in-sample and out-of-sample, using revised or real time unrevised data.

Keywords: Forecasting; Business Cycles; Yield Curve; Dynamic Factor Models; Markov Switching. (search for similar items in EconPapers)
JEL-codes: C32 E32 E44 (search for similar items in EconPapers)
Date: 2008-12, Revised 2009-04
New Economics Papers: this item is included in nep-ecm, nep-for and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:15076

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