Structural break threshold VARs for predicting US recessions using the spread

Abstract

Abstract This paper proposes a model to predict recessions that accounts for non‐linearity and a structural break when the spread between long‐ and short‐term interest rates is the leading indicator. Estimation and model selection procedures allow us to estimate and identify time‐varying non‐linearity in a VAR. The structural break threshold VAR (SBTVAR) predicts better the timing of recessions than models with constant threshold or with only a break. Using real‐time data, the SBTVAR with spread as leading indicator is able to anticipate correctly the timing of the 2001 recession. Copyright © 2006 John Wiley & Sons, Ltd.