Premium
Modelling of Economic and Financial Conditions for Real‐Time Prediction of Recessions *
Author(s) -
Çakmakli Cem,
Dem Hamza,
Altug Sumru
Publication year - 2021
Publication title -
oxford bulletin of economics and statistics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.131
H-Index - 73
eISSN - 1468-0084
pISSN - 0305-9049
DOI - 10.1111/obes.12413
Subject(s) - business cycle , recession , dynamic factor , econometrics , realization (probability) , economics , economic indicator , financial crisis , predictive power , finance , computer science , macroeconomics , mathematics , statistics , philosophy , epistemology
In this paper, we propose a method for real‐time prediction of recessions using large sets of economic and financial variables with mixed frequencies. This method combines a dynamic factor model for the extraction of economic and financial conditions together with a tailored Markov regime switching specification for capturing their cyclical behaviour. Unlike conventional methods that estimate a single common cycle governing economic and financial conditions or extract economic and financial cycles in isolation of each other, the model allows for a common cycle which is reflected with potential phase shifts in the financial conditions estimated alongside with other parameters. This, in turn, provides timely recession predictions by enabling efficient modelling of the financial cycle systematically leading the business cycle. We examine the performance of the model using a mixed frequency ragged‐edge data set for Turkey in real time. The results show evidence for the superior predictive power of our specification by signalling oncoming recessions (expansions) as early as 3.6 (3.0) months ahead of the actual realization.