The term structure and recessions: An international comparison

Thomas David Higgins, Fordham University

Abstract

This paper studies the predictive power of the yield spread in a cross-country framework using a binary probit model. The results indicate that the domestic yield spread is an accurate forecaster of future recessions and outperforms a second model that uses domestic stock returns supporting past research by Harvey (1988), Estrella and Hardouvelis (1991), and Hu (1993) amongst others. Furthermore, we determine that certain characteristics of financial markets including depth and breadth as well as the degree of openness may actually enhance the predictive power of both of these financial variables. ^ We also find that the process of globalization seems to have extended the same market forces that operate within countries beyond national borders, making the global yield spread an effective forecasting tool at the international level. As trade and financial flows between countries have surged, the scope for cross-border asset price arbitrage has increased resulting in similar pricing of comparable risks across countries. As a result, the global term structure that we calculated actually performs as well or better than the domestic yield spread in several cases. In addition, interaction terms measuring trade and investment linkages appear to enhance forecasting performance, though they tend to operate through different channels depending on whether a country runs a balance of payments deficit or surplus. ^

Subject Area

Economics, Finance

Recommended Citation

Thomas David Higgins, "The term structure and recessions: An international comparison" (January 1, 2002). ETD Collection for Fordham University. Paper AAI3037219.
http://fordham.bepress.com/dissertations/AAI3037219

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