Asymmetry in the link between the yield spread and industrial production: threshold effects and forecasting

Abstract

We analyze the nonlinear behavior of the information content in the spread for future real economic activity. The spread linearly predicts one year ahead real growth in nine industrial production sectors of the US and four of the UK over the last forty years. However, recent investigations on the spread-real activity relation have questioned both its linear nature and its time-invariant framework. Our, in-sample, empirical evidence suggests that the spread real activity relationship exhibits asymmetries that allow for different predictive power of the spread when past spread values were above or below some threshold value. We then measure the out-of-sample forecast performance of the nonlinear model using predictive accuracy tests. The results show that significant improvement in forecasting accuracy, at least for onestep ahead forecasts, can be obtained over the linear model.

Does High Yield Spread Dampen Economic Growth?

“…Gertler and Cara (1999) and Moody & Taylor (2004) found that the yield spread is significant predicting indicator for real economic activity for the United States. Paya, Venetis, and Peel (2004) suggested that the yield spread is one of the most important forecasting Kurihara /International Journal of Finance & Banking Studies Vol 3, No 2, 2014ISSN: 2147 predictors of future output changes. Also, Paya et al found that the yield spread outperforms other predicting indicators for outputs such as money, stock prices, and interest rates.…”