Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/240197 
Year of Publication: 
2021
Series/Report no.: 
Deutsche Bundesbank Discussion Paper No. 25/2021
Publisher: 
Deutsche Bundesbank, Frankfurt a. M.
Abstract: 
The equity premium follows a pronounced v-shape pattern around the beginning of recessions. It sharply drops into negative territory just before business cycle peaks and then strongly recovers as the recession unfolds. Recessions are preceded by an inverted yield curve. Thus probit models using the term spread as predictor time the beginning of recessions well. We show that such model-implied recession probabilities strongly improve equity premium prediction out-of-sample. We document a structural break in the mean of the term spread in 1982. When correcting for this break, the forecast performance further strengthens, outperforming other recently proposed benchmark predictors.
Subjects: 
Recession predictability
return predictability
business cycle
probit model
term spread
JEL: 
E32
E37
C53
G11
G17
ISBN: 
978-3-95729-833-1
Document Type: 
Working Paper

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