An assessment of the predictive abilities of the yield curve: A multi-country study

Abstract

In this thesis we assess the yield curve’s predictive abilities for the eight countries in which OECD apply the interest rate spread as a part of their leading indicator index. We develop a dynamic model that uses the yield curve and a recession lag to predict recessions. The model is tested both in-sample and pseudo out-ofsample. Our findings indicate that the yield curve still serve as a leading indicator in some of the countries, but that OECD should revise its inclusion for some of the other countries. The study differentiates itself from other studies assessing the yield curve’s predictive abilities by that we assess the relationship for different time periods, and we find that the yield curve’s significance has weakened over the last two to three decades. The weakening of the yield curve’s predictive abilities coincides with the growing awareness and focus on it as a leading indicator of recessions. Our research discusses an eminent, but little discussed, feature of research on the predictive abilities of the yield curve; that it fails to predict the onset of recessions. The thesis highlights the need for further research on several types of yield spreads and different types of recession indicators.