Business Cycle Forecasts and Futures Volatility

Abstract

This chapter assesses the extent to which the US business cycle is affected by fluctuations in futures price while controlling for other macroeconomic and financial variables. We examine the usefulness of futures volatility to predict whether or not the US economy will be in a recession. Our study builds on two research veins. The first is comprised of many studies that attempt to predict business cycles by using a range of economic variables. Many of these studies emphasize the role of financial variables in macroeconomic forecasts (Estrella and Mishkin, Review of Economics and Statistics, 80(1):45–61, 1998). This role has been certainly exacerbated during the recent financial crisis of 2007–2009. The second vein originates within the literature which widely recognizes the role of financial variables such as prices of financial instruments as leading indicators (Estrella and Mishkin, Review of Economics and Statistics, 80(1):45–61, 1998). In US data for example, equity returns and the short-term interest lead GDP growth by one or two quarters (Backus et al., Asset prices in business cycle analysis (manuscript), 2007). Commodities, combined with stocks, are one of these financial instruments that were involved in the macroeconomic forecasts. Our study examines futures volatility as predictors of US recessions. The volatility of this instrument could be an indicator of the economic situation. This study aims at either confirming or invalidating that periods of economic downturns are characterized by a high volatility in the index futures market.