Dynamic probit models and financial variables in recession forecasting

Abstract

In this paper various financial variables are examined as predictors in new dynamic probit models to predict the probability of a recession in the United States and Germany. Following the findings of previous studies, the domestic term spread proved to be an important predictive variable, but several lagged values of stock returns and the foreign term spread are also statistically significant predictive variables for both countries. The interest rate differential between the U.S. and Germany is also a useful predictor in the case of Germany. Examined dynamic probit models outperform the traditional static model giving accurate out-of-sample forecasts for the latest recession period that began in both countries in 2001.JEL Classification: C22, C25, E32, E37

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