Forecasting Recessions: Can We Do Better on MARS?

By Sephton, Peter | Review - Federal Reserve Bank of St. Louis, March/April 2001 | Go to article overview

Forecasting Recessions: Can We Do Better on MARS?


Sephton, Peter, Review - Federal Reserve Bank of St. Louis


Macroeconomists spend much of their time developing theories and building models to demonstrate how shocks propagate and affect the overall level of economic activity. Both policymakers and the private sector maintain a keen interest in understanding the state of business affairs and the most likely path the economy will take over a planning horizon. Although there are a number of economic events that concern the authorities-including excessive inflation and unemployment-considerable attention is paid to the forecasting of recession. If policymakers can anticipate a recession, they take preemptive corrective action. The private sector uses this information to shelter itself from the vagaries of the business cycle and the most likely reaction of policymakers.

Recently a number of studies have examined the ability of financial variables to forecast recessions. Many analysts find that financial indicators contain information that can be used to increase forecast accuracy. Estrella and Mishkin (1998) found that the slope of the yield curve helped predict recessions beyond one quarter. Haubrich and Dombrosky (1996), Bernard and Gerlach (1996), Dueker (1997), and Atta-Mensah and Tkacz (1998) reported similar results.1

Many of these studies employed probit models to estimate the probability of recession. Probit models are sometimes used when economists model the behavior of a dependent variable which takes on two values, e.g., recession = 1, no recession = 0. The traditional approach to probit modeling requires the researcher to choose the variables that will be included in the equation, determine their level of interaction, and assume each variable plays the same role across all recessions in the sample period. These assumptions imply that the causal nature of recessions remains fixed over time, which we know to be at odds with the stylized facts of American business cycles in the twentieth century.2 Consequently, probit models may not adequately capture the underlying processes related to recession.

The purpose of this paper is to revisit the information contained in financial variables using nonlinear, nonparametric methods, in particular, multivariate adaptive regression splines (MARS).3 As with the probit specification, MARS models provide probability forecasts that lie between zero and one, yet they admit a much wider range of possible relationships in the data. The MARS approach allows the series to enter both individually and in combination. Given the idiosyncrasies of the American business cycle, this nonlinear, nonparametric approach may provide greater insight into the factors contributing to recession while avoiding some of the pitfalls associated with the probit specification.

MODELING WITH MARS

Data

The National Bureau of Economic Research (NBER) has identified six recessions from January 1960 through September 1999. The dates of these recessions are indicated in the list below. A dichotomous dependent variable that is equal to one if the economy is in recession and equal to zero otherwise will be used as the dependent variable to be forecast.

April 1960 - February 1961

December 1969 - November 1970

November 1973 - March 1975

January 1980 -July 1980

July 1981 - November 1982

July 1990 - March 1991

Recession dates are available at the NBER Web site at http://www.nber.org.

A wide variety of financial and real variables have been used as predictors of recession and output growth. The choice of which variables to include depends on whether the analysis is undertaken on monthly or quarterly data. Here the data frequency is monthly, and we employ six variables. The slope of the yield curve (measured by the difference between the 10-year constant maturity Treasury bond rate and the rate on 3-month Treasury bills [secondary market]) has been most prominent in previous studies. Changes in real factors will be captured by the change in the logarithm of the index of industrial production as well as the change in the civilian unemployment rate.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Forecasting Recessions: Can We Do Better on MARS?
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.