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Recession Probabilities for the Eurozone at the Zero Lower Bound: Challenges to the Term Spread and Rise of Alternatives

Ralf Fendel (), Nicola Mai and Oliver Mohr

No 18-04, WHU Working Paper Series - Economics Group from WHU - Otto Beisheim School of Management

Abstract: This paper examines the recession probabilities for the Eurozone along four different dimensions: First, we identify the best performing indicators for a recession within the next 12 months based on 43 underlying single variables and their different transformations in a benchmark model. We find that a modified version of the yield curve incorporating the shadow interest rate removes the downward rigidity of the front-leg and restores part of the informational content of the term spread at the zero lower bound. However, the best performing single indicator of the benchmark model is Real M1 followed by the Purchasing Managers Index (PMI), the investment grade corporate bond spread and the Terms of Trade. Second, the paper establishes three submodels to increase the lead-time and the stability of recession models: (i) Monetary transmission channels via principal component analysis; (ii) Bivariate regressions to identify paramount combinations; (iii) Unstable surges vis-à-vis the Hodrick-Prescott trend to detect animal spirits and hawkish mistakes. Third, the analysis is extended over various forecasting horizons (6m, 18m and 24m). Fourth, the results are analyzed from the perspective of risk-affine and risk-averse investors.

Keywords: recession probability; term spread; zero lower bound; ECB; monetary transmission channel; animal spirits (search for similar items in EconPapers)
JEL-codes: E3 E32 E37 E5 E58 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec and nep-mac
Date: 2018-07-11
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