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Economic Sentiment and Yield Spreads in Europe
Author(s) -
Ferreira Eva,
Martínez Serna M. Isabel,
Navarro Eliseo,
Rubio Gonzalo
Publication year - 2008
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/j.1468-036x.2007.00389.x
Subject(s) - economics , yield (engineering) , consumption (sociology) , business cycle , investment (military) , predictive power , term (time) , econometrics , monetary economics , financial economics , macroeconomics , social science , philosophy , materials science , physics , epistemology , quantum mechanics , sociology , politics , political science , law , metallurgy
According toHarvey (1988), the forecasting ability of the term spread on economic growth is due to the fact that interest rates reflect investors' expectations about the future economic situation when deciding their plans for consumption and investment. Past literature has used ex post data on output or consumption growth as proxies for their expected value. In this paper, we employ a direct measure of economic agents' expectations, the Economic Sentiment Indicator elaborated by the European Commission, to test this hypothesis. Our results indicate that a linear combination of European yield spreads explains a surprising 93.7\% of the variability of the Economic Sentiment Indicator. This ability of yield spreads to capture economic agent expectations may be the actual reason for the predictive power of yield spreads about future business cycle.