Predicting U.S. Recessions Using the Yield Curve
Anthony M Locatelli
Senior Research Project
Submitted in partial fulfillment of the graduation requirements
for the Economics major
School of Business and Economics
April 2014
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Abstract
The literature that focuses on the association between recessions and economic indicators
is constantly increasing in size and importance. In my research I examine a particular economic
indicator, the Treasury yield spread, and its correlation to recessions. Econometric models have
continually shown an exceptionally strong relationship between historical Treasury yield spread
and recessionary data. I use several Probit regression models with recession and yield spread
data spanning from the beginning of 1953 to end of 2013 to compare the robustness of the
correlation between these two variables over time. Even though the relationship shows constant
change over time, my research findings may initiate new government and public policies for the
future.
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I. Introduction
Predicting recessions and taking actions to resolve or diminish the impact of impending
recessions has been a major concern for policy makers for decades. Economists and policy
makers use economic indicators including the CLI (Composite Leading Indicators), Treasury
yield spread, growth rate of GDP, corporate bond yield spread, and Standard and Poor’s 500
stock returns to predict recessions. In this paper I focus on the relationship between the Treasury
yield spread and recessions because it has produced robust statistical results in the past, the
literature on the topic is seemingly endless, and I contribute to the already immense literature by
examining the results of numerous regressions of different time periods to determine the
historical robustness of the relationship between the Treasury yield spread and recessions.
The yield curve plots the yield of Treasury debt against their maturity date. Yield is
synonymous for interest rate and the Treasury securities are of equal credit quality. The curve is
depicted on an x,y-plane with maturity on the x-axis and yield on the y-axis. An example of
several yield curves are shown in Figure 1 in the Appendix.
For unknown reasons, the literature suggests that the reliability of the term spread in
predicting recessions has proven extremely lacking since roughly 1985. Some proposed theories
include thoughts that the Federal Reserve has incorporated more conservative and reliable
monetary policy techniques. Monetary authorities have proven to be much more responsive and
knowledgeable when responding to inflation and output. The best way to improve the reliability
of the yield curve Probit regression model is to continually monitor its performance in order to
determine when predictions are going to be true and when others are going to be false. This is
done through further testing. It is imperative to remember that this assessment is a statistical
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measure and that regardless of the accuracy of past signals this does not guarantee future results
that are as significant as past results.
In Section II, I discuss the previous literature dealing with the relationship between the
Treasury yield spread, specifically the difference between the 10-year and 3-month yields, and
imminent recessions. I also discuss other models that economists use and their findings. In
Section III, I explain the theory behind the relationship between the Treasury yield spread and
the economy, specifically recessions. I also describe the Probit model and the variables I use in
this particular model in Section III. I present the data and descriptive statistics for my variables
in section IV. In Section V, I present the results and analysis of the data pertaining to my
research. In Section VI, I discuss my conclusions and policy implications for future use of the
Probit model. The Appendix, Section VII, contains relevant tables and figures that I discuss
throughout this paper.
II. Literature Review
The importance of this topic cannot be overstated and consequently the literature dealing
with the yield curve as a recession predictor is unbounded. Assessing its accuracy is thus a
valuable endeavor for economists and practitioners. Economists and policy makers closely
examine and follow this economic indicator closely to determine its legitimacy as a recession
predictor. Table 7 contains information pertaining to past research and the findings of the
usefulness of the yield curve for predicting recessions.
Wheelock and Wohar (2009) stress that the future state of any country’s economic
activity is essential to “consumers, investors, and policy makers”. The vast majority of recession
forecasting studies estimate a Probit model to approximate the forthcoming economic conditions.
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Using Probit estimation, Estrella and Hardouvelis (1991) and Estrella and Mishkin (1996) find
that the yield curve substantially outperforms other macroeconomic variables in forecasting U.S.
recessions. Estrella and Mishkin (1996) compare interest rates, interest rate spreads, stock prices,
monetary aggregates, and the yield curve and find that the yield curve outperforms all other
variables beyond a one-quarter forecast horizon.
Dombrosky and Haubrich (1996) mention that individuals that closely follow market
activity choose to monitor the yield curve (which generally is upward sloping and slightly
convex). Dombrosky and Haubrich (1996), among other economists and consultants, notice that
in the past the yield curve has become flat and in extreme instances has inverted. In this instance
many researchers, analysts, economists, and other specialists see this trend as indication of an
impending recession. Clark (1996) proclaims the yield curve to be a virtually flawless economic
indicator used for economic predictions.
Estrella and Trubin (2006) classify recessions via the cyclical peaks and troughs
identified by the National Bureau of Economic Research (NBER). They use the NBER monthly
dates and convert them into a monthly recession indicator by classifying a “…recession as every
month between the peak and the subsequent trough, as well as the trough itself…” (Estrella and
Trubin, 2006). The peak is not considered because the economy had grown in the previous
month. Estrella and Trubin (2006) claim these conventions to be the most frequently used in
research on U.S. recessions, but not the only possible ones.
Filardo (1999) examines five popular recession prediction models, the “…simple rules of
thumb using the Conference Board’s composite index of leading indicators (CLI), Neftҫi’s
probability model of imminent recession using the CLI, a regression-based model of the
probability of a recession called a Probit model, a GDP forecasting model, and a recession
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prediction model recently proposed by Stock and Watson”, which I detail below. They also
assess the performance of each model by assessing the timeliness and accuracy. In regards to
timeliness, a long lead time is preferred over a short lead time because a longer lead time will
have a greater time span between which a signal occurs and when the recession originates
(Filardo, 1999). Accuracy pertains to the degree in which predictions and outcomes coincide
with each other (Filardo, 1999). These two measures are imperative to monetary policy decision
making (Filardo, 1999)
Filardo (1999) notes that the CLI is a composite of ten leading indicators that were
chosen specifically for recession prediction purposes. Specialists, including the NBER, study
past data trends to select variables that would best be suited as leading indicators (Filardo, 1999).
These characteristics include: “1) conformity to the general business cycle, 2) consistent timing
as a leading indicator, 3) economic significance based on accepted business cycle theories, 4)
statistical reliability of data collection, 5) smooth month-to-month changes, and 6) reasonably
prompt publication of the data” (Filardo, 1999, p. 37). The CLI rules of thumb are simplistic in
their use and understandability, but some rules present shortcomings in the form of false signals
due to consecutive, yet small, declines and less advance warning of imminent recessions
(Filardo, 1999). However, Philip Klein and Michael Niemira revise the CLI rules of thumb by
adding a threshold which requires “…two to three months of CLI declines of at least 1.3 percent”
to reduce the chance of false signals without compromising recession identification lead time
(Filardo, 1999, p. 37). Filardo (1999) states that the CLI rules of thumb would predict recessions
half a year prior to their occurrence. Lead times and the associated rules and recessions vary
substantially and this can complicate the rule’s use in policymaking.
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Neftҫi’s model offers theoretical advantages over the CLI rules of thumb (Filardo, 1999).
Filardo (1999) notes that the model is flexible to different ideas of how recessions begin. He
gives the example: “…if an analyst believes that expansions can die of old age, the analyst can
modify the Neftҫi model to reflect this belief” (p. 37-38). The CLI rules of thumb do not offer
such flexibility. Also, the Neftҫi model can evaluate other variables other than the CLI to predict
recessions (Filardo, 1999). However, it can only evaluate one variable at a time. Filardo (1999)
finds that the forecasting performance of the Neftҫi model is only marginally better than that of
the CLI rules of thumb.
The Probit model cannot be compared to the CLI rules of thumb and the Neftҫi model as
easily because it can predict recessions at any particular forecast horizon (Filardo, 1999).
However, Filardo (1999) notes that at short forecast horizons (one to three months) the model
provides advance warning of each recession except for the 1960-1961 recession. Unfortunately,
he also reports false signals in 1966, 1983, and 1988. At long horizons (ten to twelve months) he
finds results that were confirmed earlier by Estrella and Mishkin and Lamy. The false signals
were typically short-lived, weak, and associated with relatively weak periods of economic
activity (Filardo, 1999). It is reassuring that the probabilities of recession prior to actual
occurrences were long-lasting and strong.
Filardo (1999) claims that the GDP forecasting model is a regression based framework
but tries to predict recessions by forecasting consecutive declines in GDP. The GDP forecasting
model is specified as a multi-equation regression model. The growth rate of GDP depends on
past growth rates of GDP, past growth rates of the CLI, past changes in the interest rate spread
defined as the 10-year Treasury yield minus the 3-month Treasury yield, and past changes in the
3-month Treasury yield (Filardo, 1999). To spot future recessions, the model produces GDP
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forecasts. A forecast of two consecutive quarterly declines in GDP is taken as a recession
(Filardo, 1999).
As a regression-based framework, the GDP forecasting model has many of the
advantages of the Probit model. The GDP forecasting approach may also be attractive because
analysts can choose any model that produces forecasts of GDP (Filardo, 1999). The GDP
forecasting model is not without problems. Filardo (1999) note the shortcomings of the GDP
forecasting model: 1) it has some of the unstable lead time, 2) the GDP forecasting model
predicts recessions using a 2-quarter GDP decline, which is only an approximation of the
NBER’s definition of recession, and 3) the GDP forecasting equation is a small-scale version of
a large-scale forecasting model which makes it susceptible to inconsistent forecasting
performance around turning points in the business cycle.
The GDP forecasting model had roughly the same lead time and accuracy with real-time
data as with the recently published data. The model did send false signals of recession in the
early 1980s with real-time data. However, those signals were eliminated when the GDP and CLI
data was revised (Filardo, 1999). Filardo (1999) finds results did not necessarily contradict
earlier research that find important sensitivities of GDP forecasting to data revisions.
Dombrosky and Haubrich (1996) believe that due to interest rate data availability the
convenience and cost of analysis is appropriate, but the legitimacy of such analysis must be taken
into consideration. There are many stylish and complicated macroeconometric models being
utilized by the brightest professional forecasters and it seems that at first glance the use of such a
mundane indicator as the yield curve would be deemed irrelevant (Dombrosky and Haubrich,
1996). However, Dombrosky and Haubrich (1996) state that the simple yield curve model can be
used to reaffirm or disapprove the “assumptions or relationships” of the multifaceted
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macroeconometric models used by highly trained professionals. This comparison “increases
confidence in results” when data analysis produces similar results and “signals the need for a
second look” when the results are in disagreement (Dombrosky and Haubrich, 1996).
Chauvet and Potter (2001) claim that the predictive power of the yield curve is not stable
over time even though it has been a statistically significant predictor in the past. The majority of
models that incorporate the yield curve find difficulty in predicting the 1990 recession with the
exception of Laurent (1989), Harvey (1989), and Stock and Watson (1989) (Chauvet and Potter,
2001). The potential reasons for this instability can be contributed to: 1) whether the economy is
responding to real or monetary shocks, 2) the shifts in the market for U.S. Treasury debt, and 3)
increased volatility of the U.S. economy post 1984 (Chauvet and Potter, 2001).
Wheelock and Wohar (2009) find that the yield curve can forecast output growth and
forecast recessions. The yield curve is most useful for forecasting output growth at time horizons
of 6 to 12 months, even when other variables are added to the model (Wheelock and Wohar,
2009). Wheelock and Wohar (2009), among other researchers, notice that the spread has had
diminished predictability power since the mid-1980s.
Dueker (1997) and Estella and Mishkin (1995) use a recession dummy as the dependent
variable. As with other studies, Dueker (1997) proclaims the yield curve slope to be the best
recession predictor he examines and this reinforces the claim that the yield curve should
continuously be considered as a recession predictor. The two favorable characteristics of the
yield curve that contribute to its use as a recession indicator are: 1) “…it is readily observable at
high frequencies and gives a signal that is easy to interpret”, and 2) “the expectations theory for
the term structure of interest rates provides a theoretical foundation for the predictive power of
the yield curve” (Dueker, 1997, p. 49).
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Haubrich (2006) articulates that despite the evidence that links the yield curve and
economic growth, specialists in the field of economics suggest a decreased reliability in the yield
curve’s ability to predict recessions. Due to the constant dynamics and evolution of our
economy, past success stories of the yield curve are becoming less relevant, noting the
incidences in 1995 and 1998 when a flat curve did not signal low economic growth. Wright
(2006) notes that the slope of the yield curve has continuously been cited as a leading economic
indicator, with inversion of the curve being a hint at a forthcoming recession. He notes that
growth, recessions, and interest rates are all endogenous and that association between these
variables is a simple form of correlation. Wright (2006) suggests that the 3-month minus the 10-
year spread exhibits a negative statistical relationship with real GDP over subsequent quarters
and a positive relationship with the likelihood of a recession. The term spread may be useful
because it measures the difference between current short-term interest rates and the average of
expected future short-term interest rates over a time horizon. This brings into account monetary
policy and whether it is restrictive or not.
Wright (2006) uses four Probit regression models to forecast an NBER recession at some
point in the next h quarters. His first model, which he labels model A (equation 1), is:
𝑃(𝑁𝐵𝐸𝑅𝑡,𝑡+ℎ = 1) = 𝛷(ᾶ0 + ᾶ1𝑆𝑃𝑅𝐸𝐴𝐷𝑡3𝑀−10𝑌) (1)
where NBERt,t+h is the dummy variable that equals 1 if there is an NBER-defined recession at
some point during quarters t+1 through t+h, inclusive, 𝑆𝑃𝑅𝐸𝐴𝐷𝑡3𝑀−10𝑌 is the average 3-month
minus 10-year constant maturity Treasury term spread during quarter t and Φ(.) is the standard
normal cumulative distribution function. Wright’s second model, his model B (equation 2),
incorporates the nominal federal funds rate:
𝑃(𝑁𝐵𝐸𝑅𝑡,𝑡+ℎ = 1) = 𝛷(𝛽0 + 𝛽1𝑆𝑃𝑅𝐸𝐴𝐷𝑡3𝑀−10𝑌 + 𝛽2𝐹𝐹𝑡) (2)
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where FFt is the average effective federal funds rate during quarter t. Wright (2006) notes that, in
principle, the real federal funds rate should be a better measure of the expansion or contraction to
the economy due to the stance of monetary policy. Wright’s model C adds the real federal funds
rate to his model B to test which measure, the real or nominal federal funds rate, of the stance of
monetary policy has the best predictive power. Model C (equation 3) is shown below.
𝑃(𝑁𝐵𝐸𝑅𝑡,𝑡+ℎ = 1) = 𝛷(𝛿0 + 𝛿1𝑆𝑃𝑅𝐸𝐴𝐷𝑡3𝑀−10𝑌 + 𝛿2𝐹𝐹𝑡 + 𝛿2𝑅𝐹𝑡) (3)
RFt is the real federal funds rate during quarter t. Wright (2006) uses the “log difference in the
core Personal Consumption Expenditures (PCE) price index over the previous four quarters as a
proxy for expected inflation” (p. 4).
Wright (2006) argues that the expectations hypothesis and term premium components of
the slope of the yield curve have different associations for future growth. Controlling for the
level of the federal funds rate is, as Wright (2006) puts it, the “best indirect war of accounting for
this” (p. 4). Wright (2006) notes that Cochrane and Piazzesi (2005) build off the work of
Campbell and Shiller (1991) and Fama and Bliss (1987) and find that a single linear combination
of the term structure of forward rates has substantial predictive power for the excess returns from
holding a m-year bond for one year, over those from holding a one-year bond (for m from 2 to 5).
Wright calls the “return forecasting factor” a measure of the term premium on a longer-term
bond. Wright (2006) controls for the different implications of the expectations hypothesis and
term premium components of the yield by considering the term spread, the level of the funds
rate, and the “return forecasting factor” as predictors of an NBER recession. These are
incorporated into his model D (equation 4), which is:
𝑃(𝑁𝐵𝐸𝑅𝑡,𝑡+ℎ = 1) = 𝛷(𝛾0 + 𝛾1𝑆𝑃𝑅𝐸𝐴𝐷𝑡3𝑀−10𝑌 + 𝛾2𝐹𝐹𝑡 + 𝛾2𝑅𝐹𝐹𝑡) (4)
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where RFFt is the “return forecasting factor in quarter t estimates by a regression of the average
excess return from holding an m-year bond for one year, over those from holding a one-year
bond (averages over m from 2 to 5) on the term structure of a one-year forward rates at time t.
Wright (2006) notes that this equation introduces measurement errors because it is a “noisy
proxy for the term premium” (p. 5). These four models were tested using data from the first
quarter of 1964 to the fourth quarter of 2005 and tested at horizons of 2, 4, and 6 quarters.
In Model A the coefficient on the spread is statistically significant, thus reaffirming the
historical statistical association. Model B found the coefficients of the federal funds rate and the
term spread to be statistically significant. Model C preferred the nominal funds rate and found no
significance in the coefficient of the real funds rate as noted by Wright (2006). Model D found
the coefficient of the federal funds rate to be statistically positive while the coefficient of the
return forecasting factor was statistically negative at the six quarter horizon, but not at shorter
horizons. Model B, which used the term spread and the level of the funds rate along was the best
fitting model at all horizons out of the models studied.
Wright (2006) finds that more information is in the shape of the yield curve about the
likelihood of a recession than that provided by the term spread alone. The strongest predictability
captured within a yield curve occurred when the yield curve was inverted and the nominal funds
rate was high. The Probit model using term spread alone efficiently predicted recessions with
high certainty four quarters into the future while the other models did not. The funds rate being
statistically insignificant gives support to the idea that tight monetary policy does not necessarily
support the idea of a potential sharp slowdown in economic growth.
Movements in the spread between the discount equivalent yield of a 10-year U.S. and a
3-month Treasury bill precede changes in real GDP growth. These two variables are positively
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correlated with one another as past data has indicated. The term spread contains information
concerning economic variables because it is composed of a real term spread, the expected
difference in inflation, and a term premium (Dotsey, 1998). Dotsey (1998) attempts to
characterize the relationship between output growth and the spread and analyze the predictability
of the spread along different dimensions. The different dimensions include examinations of
nonlinearities in the relationship and whether monetary policy is closely related to the predictive
content of the spread. His findings indicate that when the yield curve inverts there is a high
probability (83 percent) of a forthcoming recession.
Dotsey (1998) analyzes the predictive content of the term spread cumulatively, up to two
years, and marginally using multiple regressions and specifications. The regressions for
cumulative growth are in the form
(400/k) ln(yt+k/yt) = α0 + α1st + et (5)
where y is quarterly real GDP and s is the spread. The values for k are 2, 4, 6, and 8. The
regressions for marginal predictability are of the form
(400/2) ln(yt+k/yt+k-2) = α0 + α1st + et (6)
and analyze whether the spread helps predict two-quarter output growth k periods in the future.
The regression used to evaluate the effects of a monetary tightening and spread is noted by
(400/k) ln(yt+k/yt) = α0 + α1dtst + α2st + et (7)
where dt is a dummy variable that takes on a value of 1 if the funds rate is raised by more than 50
basis points or more over the preceding two quarters. Nonlinearities are investigated by running
this regression:
(400/k) ln(yt+k/yt) = α0 + α1hst + α2mst + α3lst + et (8)
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where hst takes on the value of the spread when the spread exceeds the average by more than
0.425 standard deviations and is zero elsewhere. Also, lst equals the spread when the spread is
below its mean by more than 0.425 standard deviations and zero if it does not. The variable mst
equals the spread when each of the previous variables is zero and is zero elsewhere. Dotsey
(1998) uses 0.425 so that each variable equals the spread roughly one-third of the time. The sum
of the variables is the spread itself. By dividing the spread into these categories analysis can be
done to check if output growth is more response to extreme spread values.
Dotsey (1998) indicates that equation 5 is significant at the 5 percent level in predicting
cumulative output growth up to two years except during the 1985-1997 period and equation 6 is
helpful at predicting two-quarter growth rates two quarters and four quarters in the future, but
becomes less informative in the more distant future. Adding monetary tightening to the
regression equation does not help to forecast recessions and neither does adding a term for
nonlinearity within the spread. The term spread contains information that is absent from past
economic activity and monetary policy.
Estrella and Mishkin (1996) study the ability of financial variables to forecast recessions
and focus on out-of-sample performance rather than in-sample. They decide to do this instead
because earlier studies mostly focused on the ability of financial variables to produce
quantitative measures of economic activity and in-sample performance. Out-of-sample
performance provides a truer test of a variables forecasting ability.
Estrella and Mishkin (1996) use their model and results to compare their forecasting
performance to the NYSE price index, the Commerce Department’s index of leading economic
indicators, and the Stock-Watson index. The performance of the four variables as assessed by
Estrella and Mishkin (1996) suggest that 1) although all of the variables have some forecasting
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ability one quarter ahead the leading indicator indexes, particularly the Stock-Watson index,
produce the best forecast results over this horizon and 2) in predicting recessions two or more
quarters in the future the yield curve dominates the other variables, and this dominance increases
as the time horizon grows.
Results suggest that the yield curve spread can have useful macroeconomic prediction
capabilities and this is particularly true with long lead times. Long lead times are valued highly
by policymakers because policy actions involve substantial time lags. The yield curve can
supplement other econometric models for three key reasons. These reasons, as explained by
Estrella and Mishkin (1996), are 1) forecasting with the yield curve is quick and simple, 2) the
yield curve can be used to check econometric and judgmental predictions by identifying
problems that could have gone overlooked otherwise, and 3) the yield curve produces a
probability of recession that is of interest in its own right.
III. Theoretical Model
The intention of my research is to examine the yield spread and its correlation to
recessions prior to 2014. The Probit regression model used in my study is:
𝑅𝐸𝐶𝐸𝑆𝑆𝐼𝑂𝑁𝑡+4 = 𝛽0 + 𝛽1𝑆𝑃𝑅𝐸𝐴𝐷𝑡 + 휀𝑡 (9)
I examine the model nine times during different historical time periods. One regression is
a culmination of all recession and yield curve data from the second quarter of 1953 to the fourth
quarter of 2013. Two more regressions are used to predict recessions prior to the first quarter in
1986 and another beginning in the first quarter of 1986. I also run regressions to predict the
robustness over time by predicting recessions every ten years beginning in 1954 and ending in
the last quarter of 2013.
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In the Probit regression model I use in my study, SPREADt is the difference between the
10-year Treasury security and secondary market 3-month rate expressed on a bond-equivalent
basis in quarter t (lagged four quarters), β0 is a constant, t represents time (a quarter within a
particular year), β1 is my coefficient, εt is an error term, and RECESSIONt+4 is a dummy variable
that can take on two values: 0 if the observation is an expansion and 1 if it is a recession, in a
particular quarter. I obtain information for RECESSIONt-+4 via the NBER which dates the
official beginning and end of recessions. Table 1 gives a description of the variables and the
hypothesized sign of the variable’s effect.
Dombrosky and Haubrich (1996) and Wheelock and Wohar (2009) note that the
underlying economic theories concerning the predictive power of the yield curve are pertinent.
They note that under the expectations hypothesis theory, long-term interest rates are the average
of expected future short-term rates plus a term premium. The term premium is essentially the
extra interest received for holding a Treasury security with a longer maturity date. If today’s one-
year rate is 8 percent and next year’s one-year rate is expected to be 10 percent, the two-year rate
should be 9 percent ([8+10] / 2 = 8). Therefore if low interest rates are associated with
recessions, then an inverted term structure – which suggests that future rates will be lower –
should reasonably predict a recession. Wheelock and Wohar (2009) also note that the term
premium explains why the yield curve generally slopes upward (yields on long-term securities
exceed those on short-term securities).
The yield curve predicts future output because shifts in interest rates follow from the
same underlying cause: monetary policy. The yield curve reflects future output indirectly, by
predicting future interest rates or future monetary policy. It may also reflect future output
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directly, because the 10-year interest rate may depend on the market’s guess of output in 10
years. These explanations provide motivation for investigating yield curve predictions.
Estrella and Trubin (2006) note that current literature on the yield curve and recessions
has been largely empirical in nature and is generally concerned with the correlation between the
two instead of theorizing why this correlation exists. However, they recognize that there are
numerous explanations for such correlation and a large quantity of these explanations can be
found in the earliest literature dealing with this topic. They go on to explain why monetary
policy and investor expectations provide a robust explanation of why the relationship between
the yield curve and recessions exists.
Estrella and Trubin (2006) and Wheelock and Wohar (2009) illuminate the idea that a
tight monetary policy generally causes both short-term and long-term interest rates to rise which
causes the cost of borrowing to increase, thus lowering the amount of spending within an
economy. However, short-term rates are expected to rise more than long-term rates once
economic activity slows or inflation declines (Wheelock and Wohar, 2009). This process is
implemented during a booming economy when the Federal Reserve believes the economic
growth is occurring too quickly or when they foresee inflation rising beyond desirable levels.
Estrella and Trubin (2006) and Wheelock and Wohar (2009) find that this monetary tightening
slows down the economy and can flatten or invert the yield curve.
IV. Presentation of Data
Table 2 shows NBER dated recessions and the peak and trough year and accompanying
quarter for each economic contraction. The duration of each recession in Table 2 is in months.
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Table 3 provides descriptive statistics for my independent variable, the 10-year minus 3-month
spread, that I use in each of my nine regressions.
The 10-year constant maturity rate and the secondary market 3-month discount rate are
used for my spread. Estrella and Trubin (2006) suggest that maximum accuracy and predictive
power are achieved when the secondary market 3-month rate is expressed on a bond-equivalent
basis. Also, data on the three-month constant maturity rate is available only back to January 1982
which makes it an unfavorable choice for examining data prior to 1982. The secondary market 3-
month rate is expressed on a bond-equivalent basis. Estrella and Trubin (2006) make this
conversion possible via the following equation (“discount” is the yield expresses in percentage
points):
𝑏𝑜𝑛𝑑 − 𝑒𝑞𝑢𝑎𝑣𝑖𝑙𝑒𝑛𝑡 = 100 × (365 ×𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡
100)/(360 − 91 ×
𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡
100) (10)
I also use this equation to convert my secondary market 3-month discount rate data to a bond-
equivalent. I use quarterly averages for my spread. I use term spread data from the second
quarter of 1953 through the fourth quarter of 2012 to analyze recessions that occurred from the
second quarter of 1954 through the fourth quarter of 2013. Wright (2006) notes that the data on
long-term yields before 1964 may be unreliable because at this time the vast majority of long
maturity bonds had distorted prices due to being callable or “flower bonds” (redeemable at par in
payment of estate taxes). The data for the Treasury yield curve spread (10-year constant maturity
rate and the secondary market 3-month discount rate) is obtained via the Board of Governors of
the Federal Reserve System’s H.15 Report.
I collect recession data from the National Bureau of Economic Research’s US Business
Cycle Expansions and Contractions. I use data lagged four quarters because Estrella and
Hardouvelis (1991), Estrella and Mishkin (1996), Deuker (1997), Chauvet and Potter (2005),
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Dotsey (1998), and Wright (2006) all find the spread useful for forecasting recessions 4-quarters
ahead. My research focuses more on the robustness of the correlation throughout history and
therefore using a 4-quarter lag was appropriate because prior research shows this particular lags
legitimacy. Figure 2 plots the spread I use in my regression analysis and the grey shaded areas
indicate recessions as designated by NBER.
The spread has been shown to predict recessions more effectively than output growth,
especially as the time horizon increases. It is vital to define recessions at the periods defined by
the NBER because they are most relevant and have also proven to produce very significant
results. Also, the treasury rates used for the model are best because they are very “naked” rates
meaning that they are not extremely complicated to interpret because their underlying “drivers”,
or “movers”, are generally basic in nature.
A. 1954 – 1963 Model
In this model, a recession ended in the second quarter of 1954 which is the start of the
data I used for recession dating. Another recession began in the third quarter of 1957 and ended
in the second quarter of 1958. A third recession began in the second quarter of 1960 and ended in
the first quarter of 1961. These were the three occurrences of recessions during this ten year
span. The mean 10-year less 3-month spread is 1.05%, the minimum spread is 0.24%, the
maximum spread was 1.95%, and the standard deviation is 0.46%.
19
B. 1964 – 1973 Model
In this model the first recession began in the fourth quarter of 1969 and ended in the last
quarter of 1970. The second recession began just years later in the fourth quarter of 1973, which
is the last observation for this particular model. The mean 10-year less 3-month spread is 0.66%,
the minimum spread is -0.39%, the maximum spread is 2.52%, and the standard deviation is
0.76%.
C. 1974 – 1983 Model
This model saw a recession occur from the first quarter of 1974 through to the first
quarter of 1975. Another recession begin in the first quarter of 1980 and ended shortly after in
the third quarter of 1980. A year later another recession began in the third quarter of 1981 and
ended in the fourth quarter of 1982. The mean 10-year less 3-month spread is 0.61%, the
minimum spread is -2.18%, the maximum spread is 3.44%, and the standard deviation is 1.63%.
D. 1984 – 1993 Model
In this model a recession began in the third quarter of 1990 and ended in the first quarter
of 1991. This was the only NBER dated recession in this ten year time span. The mean 10-year
less 3-month spread is 2.03%, the minimum spread is -0.01%, the maximum spread is 3.61%,
and the standard deviation is 1.02%.
20
E. 1994 – 2003 Model
The first recession that occurred in this model was in the first quarter of 2001 and the
recession ended in the fourth quarter of the same year. This was the only observed NBER
recession in this model. The mean 10-year less 3-month spread is 1.47%, the minimum spread is
-0.63%, the maximum spread is 3.35%, and the standard deviation is 1.09%.
F. 2004 – 2013 Model
The recession of 2007 began in the fourth quarter and lasted until the second quarter of
2009. As with the previous two models, only one recession was observed during this ten year
time span. The mean 10-year less 3-month spread is 1.99%, the minimum spread is -0.44%, the
maximum spread is 3.61%, and the standard deviation is 1.24%.
G. 1954 – 1985 Model
Seven recessions were observed prior to 1986. The average duration of these recessions
was eleven months. The mean 10-year less 3-month spread is 0.87%, the minimum spread is
-2.18%, the maximum spread is 3.44%, and the standard deviation is 1.12%.
H. 1986 – 2013 Model
Three recessions were observed post 1985. The average duration of these recessions was
eleven and one-third months. The mean 10-year less 3-month spread is 1.79%, the minimum
spread is -0.63%, the maximum spread is 3.61%, and the standard deviation is 1.17%.
21
I. 1954 – 2013 Model
Ten total recessions were observed for the data I used in my study and the average
recession duration was eleven and one-tenth months. The mean 10-year less 3-month spread is
1.30%, the minimum spread is -2.18%, the maximum spread is 3.61%, and the standard
deviation is 1.23%.
V. Results
Table 4 presents parameter estimates for my Probit regressions including coefficients,
constants, Wald test statistics, p-values, and McFadden pseudo R-squared statistics which are
detailed below in subsection A. Table 5 presents model fitting information which is discussed in
subsection B. Table 6 presents econometric results and probability of recessions occurring, based
on spread, which I discuss in subsection C. These tables are shown in the appendix. In my
analysis of results I use a significance level of 10%. Statistically significant coefficients are
bolded and italicized in Table 4 and Table 5.
A. Probit Parameter Estimates
In Table 4 I provide parameter estimates for β1 and β0 for each regression I run. The
Estimate column provides regression coefficients and the predicted probability of a recession can
be calculated using these coefficients. A negative β1 means that a decrease in SPREADt leads to
an increase in the predicted probability and vice versa. My regression outputs are designed to be
implemented in equation 11 below to assign an estimated probability of a recession four quarters
(t+4) into the future based on the yield spread at time at some point (t). For a particular spread,
β1, and β0, the predicted probability of a recession is
22
𝐹[𝛽0 + (𝑆𝑃𝑅𝐸𝐴𝐷𝑡 × 𝛽1)] (11)
where F is the standard normal cumulative distribution function (shown is equation 12).
𝐹(𝑧) = ∫ 1/√2𝜋 exp (−𝑥2
2) 𝑑𝑥
𝑧
−∞ (12)
I use Microsoft Excel and the standard normal cumulative distribution function to produce
results which I transpose onto Figure 3 in the Appendix. In Figure 3, P(10) represents the
predicted probability of a recession occurring based off of the outputs from the six regressions
that were broken into 10 year increments, P(54-85) represents the predicted probability of a
recession occurring based off of the outputs from the regression that uses data prior to 1986 and
after 1953, P(85-13) represents the predicted probability of a recession occurring based off of the
outputs from the regression that uses data after 1985 and prior to 2014, and P(comp) represents
the predicted probability of a recession occurring based off of the outputs from the regression
that includes all of the data that I utilize in my research. The grey shaded areas indicate periods
designated as national recessions by NBER.
The Wald statistic in Table 4 is the test statistic for the individual regression coefficients
and constants. The Wald test statistic is the squared ratio of the regression constant or
coefficient, β0 or β1 respectively, to the standard error of the respective constant or coefficient.
The test statistic follows a Chi-Square distribution which is used to test against a two-sided
alternative hypothesis that the Estimate is not equal to zero.
The Sig. column in Table 4 provides the p-value of the estimates, or probability that the
null hypothesis that a predictor’s regression coefficient is zero. The p-values are based on the
Wald test statistics of the predictor. The probability that a Wald test statistic is as extreme, or
more extreme, than what has been observed under the null hypothesis is defined by the p-values.
23
The McFadden column contains McFadden's pseudo R-squared which does its best to
mirror the R-squared obtained in OLS (ordinary least squares) regressions. The R-Squared in
OLS explains variability and improvement from a null model to a final (fitted) model. The
equation for McFadden's pseudo R-squared is shown below where MFull = model with predictors,
MIntercept = model without predictors, and Ḽ = estimated likelihood.
𝑅2 = 1 −𝑙𝑛 Ḽ(𝑀𝐹𝑢𝑙𝑙)
𝑙𝑛 Ḽ(𝑀𝐼𝑛𝑡𝑒𝑟𝑐𝑒𝑝𝑡) (13)
The log likelihood of the intercept model mirrors a total sum of squares that goes into an OLS R-
squared calculation, and the log likelihood of the full model mirrors the sum of squared errors
that can be found in an OLS R-squared calculation as well. A likelihood falls between 0 and 1, so
the log of a likelihood is less than or equal to zero. If a model has a very low likelihood, then the
log of the likelihood will have a larger magnitude than the log of a more likely model. Therefore,
a small ratio of log likelihoods indicates that the full model is a far better fit than the intercept
model. If comparing two models, McFadden's would be higher for the model with the greater
likelihood.
B. Model Fitting Information
In Table 5, the -2 Log Likelihood columns show the product of -2 and the log likelihoods
of the null (β0) model and the final (β1) model. These measures are used to test whether or not the
coefficients of the predictors are zero. The Chi-Square column is the Likelihood Ratio Chi-
Square test that at least one of the predictors’ regression coefficient is not equal to zero in the
model (in my study there is only one predictor). The Likelihood Ratio Chi-Square statistic is
simply the difference between the null model and the final model which can be seen in Table 5.
The Sig. column is the probability of getting a Likelihood Ratio test statistic as extreme as, or
24
more so, than the observed under the null hypothesis. The null hypothesis is that all of the
regression coefficients in the model are equal to zero. Small p-values (less than 0.10) lead to
conclusions that the regression coefficient in the model is not equal to zero.
C. Probabilities based on spread.
Table 6 provides probability results for each of the nine regressions based on spread. For
each probability value, a specific spread is calculated. It is evident from this table that as the
difference in spread treads negatively, the probability of a recession increases. I use the inverse
of the standard normal cumulative distribution to obtain these results.
A. 1954 – 1963 Model
The 10-year less 3-month spread coefficient (β1) is -2.150. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 2.150. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is -1.187 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(-1.187) = 0.1176. So the predicted probability of a
recession occurring when the spread is 0 is 11.76%.
The Wald test statistic for RECESSIONt+4 is 3.823 and the p-value is 0.051 which means
that at my alpha level of 0.10 I reject the null hypothesis and conclude that the model intercept
(β0) has been found to be statistically different from zero given SPREADt is in the model. The
Wald test statistic for the predictor SPREADt is 10.184 and the p-value is 0.001 which means that
at my alpha level of 0.10 I reject the null hypothesis and conclude that the regression coefficient
(β1) has been found to be statistically different from zero in estimating SPREADt.
25
McFadden's pseudo R-squared for this model was 0.318. For the models that were split
into ten year increments this model had the third highest McFadden's pseudo R-squared and the
fourth highest out of the nine regressions.
The Chi-Square statistic for this model is 13.412 and the associated p-value is less than
0.000 which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in
this model is not equal to zero.
B. 1964 – 1973 Model
The 10-year less 3-month spread coefficient (β1) is -0.931. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 0.931. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is 0.634 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(0.634) = 0.7370. So the predicted probability of a
recession occurring when the spread is 0 is 73.70%.
The Wald test statistic for RECESSIONt+4 is 4.370 and the p-value is 0.037 which means
that at my alpha level of 0.10 I reject the null hypothesis and conclude that the model intercept
(β0) has been found to be statistically different from zero given SPREADt is in the model. The
Wald test statistic for the predictor SPREADt is 3.045 and the p-value is 0.081 which means that
at my alpha level of 0.10 I reject the null hypothesis and conclude that the regression coefficient
(β1) has been found to be statistically different from zero in estimating SPREADt.
McFadden's pseudo R-squared for this model was 0.146. For the models that were split
into ten year increments this model had the lowest McFadden's pseudo R-squared and the
absolute lowest out of the nine regressions.
26
The Chi-Square statistic for this model is 4.944 and the associated p-value is 0.026
which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in this
model is not equal to zero.
C. 1974 – 1983 Model
The 10-year less 3-month spread coefficient (β1) is -0.535. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 0.535. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is 0.201 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(0.201) = 0.5795. So the predicted probability of a
recession occurring when the spread is 0 is 57.95%.
The Wald test statistic for RECESSIONt+4 is 0.725 and the p-value is 0.395 which means
that at my alpha level of 0.10 I fail to reject the null hypothesis and conclude that the model
intercept (β0) has not been found to be statistically different from zero given SPREADt is in the
model. The Wald test statistic for the predictor SPREADt is 11.237 and the p-value is 0.001
which means that at my alpha level of 0.10 I reject the null hypothesis and conclude that the
regression coefficient (β1) has been found to be statistically different from zero in estimating
SPREADt.
McFadden's pseudo R-squared for this model was 0.266. For the models that were split
into ten year increments this model had the second lowest McFadden's pseudo R-squared and the
third lowest out of the nine regressions.
27
The Chi-Square statistic for this model is 13.752 and the associated p-value is less than
0.000 which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in
this model is not equal to zero.
D. 1984 – 1993 Model
The 10-year less 3-month spread coefficient (β1) is -3.084. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 3.084. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is -0.705 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(-0.705) = 0.2405. So the predicted probability of a
recession occurring when the spread is 0 is 24.05%.
The Wald test statistic for RECESSIONt+4 is 0.890 and the p-value is 0.345 which means
that at my alpha level of 0.10 I fail to reject the null hypothesis and conclude that the model
intercept (β0) has not been found to be statistically different from zero given SPREADt is in the
model. The Wald test statistic for the predictor SPREADt is 2.569 and the p-value is 0.109 which
means that at my alpha level of 0.10 I fail to reject the null hypothesis and conclude that the
regression coefficient (β1) has not been found to be statistically different from zero in estimating
SPREADt.
McFadden's pseudo R-squared for this model was 0.674. For the models that were split
into ten year increments this model had the highest McFadden's pseudo R-squared and also the
highest overall out of the nine regressions.
28
The Chi-Square statistic for this model is 14.364 and the associated p-value is less than
0.000 which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in
this model is not equal to zero.
E. 1994 – 2003 Model
The 10-year less 3-month spread coefficient (β1) is -1.959. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 1.959. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is -0.022 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(-0.022) = 0.4913. So the predicted probability of a
recession occurring when the spread is 0 is 49.13%.
The Wald test statistic for RECESSIONt+4 is 0.002 and the p-value is 0.966 which means
that at my alpha level of 0.10 I fail to reject the null hypothesis and conclude that the model
intercept (β0) has not been found to be statistically different from zero given SPREADt is in the
model. The Wald test statistic for the predictor SPREADt is 5.053 and the p-value is 0.025 which
means that at my alpha level of 0.10 I reject the null hypothesis and conclude that the regression
coefficient (β1) has been found to be statistically different from zero in estimating SPREADt.
McFadden's pseudo R-squared for this model was 0.463. For the models that were split
into ten year increments this model had the second highest McFadden's pseudo R-squared and
also the second highest overall out of the nine regressions.
The Chi-Square statistic for this model is 12.048 and the associated p-value is 0.001
which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in this
model is not equal to zero.
29
F. 2004 – 2013 Model
The 10-year less 3-month spread coefficient (β1) is -0.750. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 0.750. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is -0.191 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(-0.191) = 0.4241. So the predicted probability of a
recession occurring when the spread is 0 is 42.41%.
The Wald test statistic for RECESSIONt+4 is 0.216 and the p-value is 0.642 which means
that at my alpha level of 0.10 I fail to reject the null hypothesis and conclude that the model
intercept (β0) has not been found to be statistically different from zero given SPREADt is in the
model. The Wald test statistic for the predictor SPREADt is 8.911 and the p-value is 0.003 which
means that at my alpha level of 0.10 I reject the null hypothesis and conclude that the regression
coefficient (β1) has been found to be statistically different from zero in estimating SPREADt.
McFadden's pseudo R-squared for this model was 0.317. For the models that were split
into ten year increments this model had the third lowest McFadden's pseudo R-squared and
ranked fifth out of all nine regressions.
The Chi-Square statistic for this model is 11.767 and the associated p-value is 0.001
which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in this
model is not equal to zero.
G. 1954 – 1985 Model
The 10-year less 3-month spread coefficient (β1) is -0.679. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 0.679. This means that an increase in the
30
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is 0.336 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(0.336) = 0.6315. So the predicted probability of a
recession occurring when the spread is 0 is 63.15%.
The Wald test statistic for RECESSIONt+4 is 4.690 and the p-value is 0.030 which means
that at my alpha level of 0.10 I reject the null hypothesis and conclude that the model intercept
(β0) has been found to be statistically different from zero given SPREADt is in the model. The
Wald test statistic for the predictor SPREADt is 22.955 and the p-value is less than 0.000 which
means that at my alpha level of 0.10 I reject the null hypothesis and conclude that the regression
coefficient (β1) has been found to be statistically different from zero in estimating SPREADt.
McFadden's pseudo R-squared for this model was 0.217. Out of the three models that
were not split into ten year increments this model had the lowest McFadden's pseudo R-squared
and the second lowest out of all nine regressions.
The Chi-Square statistic for this model is 29.657 and the associated p-value is less than
0.000 which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in
this model is not equal to zero.
H. 1986 – 2013 Model
The 10-year less 3-month spread coefficient (β1) is -0.962. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 0.962. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is 0.054 meaning that if the 10-year less 3-month spread is evaluated at zero the
31
predicted probability of a recession is F(0.054) = 0.5214. So the predicted probability of a
recession occurring when the spread is 0 is 52.14%.
The Wald test statistic for RECESSIONt+4 is 0.042 and the p-value is 0.837 which means
that at my alpha level of 0.10 I fail to reject the null hypothesis and conclude that the model
intercept (β0) has not been found to be statistically different from zero given SPREADt is in the
model. The Wald test statistic for the predictor SPREADt is 15.268 and the p-value is less than
0.000 which means that at my alpha level of 0.10 I reject the null hypothesis and conclude that
the regression coefficient (β1) has been found to be statistically different from zero in estimating
SPREADt.
McFadden's pseudo R-squared for this model was 0.344. Out of the three models that
were not split into ten year increments this model had the highest McFadden's pseudo R-squared
and the third highest out of all nine regressions.
The Chi-Square statistic for this model is 29.038 and the associated p-value is less than
0.000 which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in
this model is not equal to zero.
I. 1954 – 2013 Model
The 10-year less 3-month spread coefficient (β1) is -0.753. For a one unit increase in the
10-year less 3-month spread, the z-score decreases by 0.753. This means that an increase in the
spread decreases the predicted probability of a recession, and vice versa. The constant term
coefficient (β0) is 0.274 meaning that if the 10-year less 3-month spread is evaluated at zero the
predicted probability of a recession is F(0.274) = 0.6079. So the predicted probability of a
recession occurring when the spread is 0 is 60.79%.
32
The Wald test statistic for RECESSIONt+4 is 4.189 and the p-value is 0.041 which means
that at my alpha level of 0.10 I reject the null hypothesis and conclude that the model intercept
(β0) has been found to be statistically different from zero given SPREADt is in the model. The
Wald test statistic for the predictor SPREADt is 40.298 and the p-value is less than 0.000 which
means that at my alpha level of 0.10 I reject the null hypothesis and conclude that the regression
coefficient (β1) has been found to be statistically different from zero in estimating SPREADt.
McFadden's pseudo R-squared for this model was 0.275. Out of the three models that
were not split into ten year increments this model had the second highest McFadden's pseudo R-
squared and ranked sixth out of all nine regressions.
The Chi-Square statistic for this model is 61.867 and the associated p-value is less than
0.000 which, at my alpha level of 0.10, leads to the conclusion that my regression coefficient in
this model is not equal to zero.
VI. Conclusions and Policy Implications
The research findings of this paper are quite encouraging. The results indicate that
models which use the yield curve spread may be useful in predicting recessions and thus may be
useful in policy making. The yield curve spread was significant at an alpha level of 0.10 in each
regression except the 1984-1993 model. I run regression models of yield curve data at a specific
time against recession data one year in the future. Due to my robust findings I am confident that
the yield curve can produce similar results in the future which can be used to predict imminent
recessions. It is important to lag the yield spread to predict future economic activity because the
action of policy makers generally has a lagged effect itself.
33
I find some similarities in using the yield curve that Estrella and Mishkin (1996) make
note of in their research. They note that the yield curve is quick and simple for forecasting, it can
be used to double-check econometric models and theoretical predictions, and it is useful in
predicting future recessions, which is of high interest to policy makers. An observer can simply
compare the 10-year and 3-month rates and instantly make assumptions about forthcoming
economic activity. One could take this a step further by running regressions and using the
outputs to assign a probability to a potential recession. These results can then be compared
against other econometric procedures used for predicting recessions.
The Probit model is certainly not perfect. Predictions are subject to error simply because
they are statistical estimates. However, the model I use in my research can be used in the future
by the Federal Reserve and government officials to test and reevaluate other models that are
currently used for predicting recessions. As always, caution must be taken in using this data
because future results may not be indicative of previous data. Also, the Federal Reserve is more
informed than ever before and controls rates to compensate economic swings. In the future I
would suggest economists who research recessions to test models with various other economic
indicators.
34
VII. Appendix
Table 1: Variables and Expected Coefficients
Variable Name Description Expected Coefficient Sign
RECESSIONt+4
A dummy variable for a recession
occurring in the quarter t + 4 from
the standpoint of the available
information in quarter t
Dependent Variable
SPREADt
The difference between the 10-year
Treasury security and 3-month
Treasury security interest rate in
quarter t
-
Table 2: Recessions According to NBER
Peak Trough Recession Duration
(Year & Quarter) (Year & Quarter) (In Months)
1953 Q2 1954 Q2 10
1957 Q3 1958 Q2 8
1960 Q2 1961 Q1 10
1969 Q4 1970 Q4 11
1973 Q4 1975 Q1 16
1980 Q1 1980 Q3 6
1981 Q3 1982 Q4 16
1990 Q3 1991 Q1 8
2001 Q1 2001 Q4 8
2007 Q4 2009 Q2 18
35
VII. Appendix (Continued)
Table 3: 10-Year Minus 3-Month Descriptive Statistics
Model Range Minimum Maximum Mean Standard
Deviation
1954-1963 1.71 0.24 1.95 1.05 0.46
1964-1973 2.91 -0.39 2.52 0.66 0.76
1974-1983 5.62 -2.18 3.44 0.61 1.63
1984-1993 3.62 -0.01 3.61 2.03 1.02
1994-2003 3.98 -0.63 3.35 1.47 1.09
2004-2013 4.05 -0.44 3.61 1.99 1.24
1954-1985 5.62 -2.18 3.44 0.87 1.12
1986-2013 4.24 -0.63 3.61 1.79 1.17
1954-2013 5.79 -2.18 3.61 1.30 1.23
36
VII. Appendix (Continued)
Table 4: Probit Parameter Estimates
Model Estimate Wald Sig. McFadden
1954-1963 (β1) -2.150 10.184 0.001 0.318
1954-1963 (β0) -1.187 3.823 0.051
1964-1973 (β1) -0.931 3.045 0.081 0.146
1964-1973 (β0) 0.634 4.370 0.037
1974-1983 (β1) -0.535 11.237 0.001 0.266
1974-1983 (β0) 0.201 0.725 0.395
1984-1993 (β1) -3.084 2.569 0.109 0.674
1984-1993 (β0) -0.705 0.890 0.345
1994-2003 (β1) -1.959 5.053 0.025 0.463
1994-2003 (β0) -0.022 0.002 0.966
2004-2013 (β1) -0.750 8.911 0.003 0.317
2004-2013 (β0) -0.191 0.216 0.642
1954-1985 (β1) -0.679 22.955 0.000 0.217
1954-1985 (β0) 0.336 4.690 0.030
1986-2013 (β1) -0.962 15.268 0.000 0.344
1986-2013 (β0) 0.054 0.042 0.837
1954-2013 (β1) -0.753 40.298 0.000 0.275
1954-2013 (β0) 0.274 4.189 0.041
37
VII. Appendix (Continued)
Table 5: Model Fitting Information
Model -2 Log Likelihood (β0) -2 Log Likelihood (β1) Chi-Square Sig.
1954-1963 42.136 28.724 13.412 .000
1964-1973 33.817 28.873 4.944 .026
1974-1983 51.796 38.043 13.752 .000
1984-1993 21.311 6.947 14.364 .000
1994-2003 26.007 13.959 12.048 .001
2004-2013 37.098 25.331 11.767 .001
1954-1985 136.467 106.810 29.657 .000
1986-2013 84.397 55.359 29.038 .000
1954-2013 225.265 163.399 61.867 .000
Table 6: Estimated Recession Probabilities from Nine Probit Regressions
Recession
Probability
Value of Spread (Percentage Points)
54-63 64-73 74-83 84-93 94-03 04-13 54-85 86-13 54-13
5% 0.213 2.448 3.450 0.305 0.828 1.938 2.919 1.766 2.548
10% 0.044 2.058 2.771 0.187 0.643 1.453 2.384 1.388 2.066
15% -0.070 1.794 2.312 0.108 0.518 1.127 2.022 1.133 1.740
20% -0.161 1.585 1.948 0.044 0.418 0.867 1.735 0.931 1.481
25% -0.239 1.406 1.636 -0.010 0.333 0.644 1.489 0.757 1.259
30% -0.308 1.244 1.355 -0.058 0.257 0.444 1.268 0.601 1.060
40% -0.434 0.953 0.848 -0.146 0.118 0.083 0.868 0.319 0.700
50% -0.552 0.681 0.375 -0.229 -0.011 -0.255 0.495 0.056 0.364
60% -0.670 0.409 -0.099 -0.311 -0.140 -0.593 0.121 -0.208 0.027
70% -0.796 0.118 -0.605 -0.399 -0.279 -0.954 -0.278 -0.490 -0.333
80% -0.944 -0.223 -1.198 -0.501 -0.441 -1.377 -0.746 -0.819 -0.754
90% -1.148 -0.696 -2.021 -0.644 -0.665 -1.963 -1.394 -1.277 -1.339
38
VII. Appendix (Continued)
Table 7: Studies of the Usefulness of the Yield Curve for Predicting Recessions
Literature Methodology Data (years) Findings
Estrella and
Hardouvelis (1991) Probit model U.S. (1955-88)
Spread is useful for
forecasting recessions 4
quarters ahead.
Dotsey (1998) Probit model U.S. (1955-97) Spread is useful for
prediction.
Estrella and
Mishkin (1996) Probit model U.S. (1959-95)
Spread is useful for
prediction, especially at 2-
to 6-quarter horizons
Bernard and
Gerlach (1998) Probit model
8 industrialized
countries (1972-93)
Spread is useful for
prediction at 4- to 8-
quarter horizons
Estrella, Rodrigues,
and Schich (2003) Probit model
U.S. (1955-98) and
Germany (1967-98)
Spread is useful for
prediction at 12-month
horizons, less so at 24-
and 26-month horizons.
Chauvet and Potter
(2005)
Variants of Probit
model allowing for
multiple structural
breaks and
autoregression
U.S. (1954-2001)
Spread is useful for
prediction at 12-month
horizons.
Wright (2006) Probit model U.S. (1964-2005) Spread is useful for
predicting recessions.
Rosenberg and
Maurer (2008) Probit model U.S. (1961-2006)
The expectations
component of the spread
is more accurate than the
term premium component
at forecasting recessions.
SOURCE: Wheelock, David C. and Wohar, Mark E. 2009. “Can the Term Spread Predict
Output Growth and Recessions? A Survey of the Literature.” Federal Reserve Bank of St.
Louis, Review. Volume 91, Number.
39
VII. Appendix (Continued)
0
2
4
6
8
10
12
14
16
18
3 -mo. 6-mo. 1-yr. 2-yr. 3-yr. 5-yr. 7-yr. 10-yr. 30-yr.
Per
cent
(Wee
kly
Aver
age)
Maturity
Yield Curves
2/18/1977
12/1/1978
3/28/1980
10/16/1987
2/15/2002
8/18/2006
Figure 1
-3.00
-2.00
-1.00
0.00
1.00
2.00
3.00
4.00
2 Q
1954
2 Q
1958
2 Q
1962
2 Q
1966
2 Q
1970
2 Q
1974
2 Q
1978
2 Q
1982
2 Q
1986
2 Q
1990
2 Q
1994
2 Q
1998
2 Q
2002
2 Q
2006
2 Q
2010
Per
cen
tage
Lagged Yield Spread & NBER Recessions
NBER Dated Recessions (Quarterly) 10-year, 3-month spread (Lagged 4 quarters)
Figure 2
40
VII. Appendix (Continued)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2 Q1954
2 Q1957
2 Q1960
2 Q1963
2 Q1966
2 Q1969
2 Q1972
2 Q1975
2 Q1978
2 Q1981
2 Q1984
2 Q1987
2 Q1990
2 Q1993
2 Q1996
2 Q1999
2 Q2002
2 Q2005
2 Q2008
2 Q2011
Predicted Probability of U.S. Recession Twelve Months Ahead
NBER Dated Recessions (Quarterly) P(10) P(54-85) P(85-13) P(Comp)
Figure 1
41
VIII. References
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Wheelock, David C. and Wohar, Mark E. 2009. “Can the Term Spread Predict Output Growth
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Volume 91, Number.
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Wright, Jonathan H. 2006. “The Yield Curve and Predicting Recessions.” Federal Reserve
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