Recession Probabilities

Abstract

Statistical models that estimate 12-month-ahead recession probabilities using the term spread have been around for many years. However, the reliability of the term spread as a predictor may have been affected by short-term interest rates being at zero. At the zero lower bound, long-term yields cannot go too far into negative territory due to the portfolio constraints of institutional investors. Therefore, the yield curve may not invert when it should or as much as it should despite the anticipated path of the economy. I enhance the simple model with two variables that should have predictive power for recessions.