Working Paper Series no. 128: Do financial markets forecast economic turning points?

Abstract

This article aims at estimating leading indicators of the American economy with financial variables. We use two types of hidden Markov chains models, a quantitative one (Krolzig (1997)) and a qualitative one (Gregoir and Lenglart (2000)). These models provide a robust and reliable framework to build with financial variables a qualitative probabilistic indicator with a 3- to 6-month lead on business and growth cycle. During the last forty years, the financial market rarely proved false signals and identified all recessions -which are dated by the NBER- and slowdowns periods of the American economy.

Benoît Bellone, Erwan Gautier and Sébastien Le Coent
July 2005

Classification JEL : C32, E32, E44.

Keywords : Business cycles, Qualitative multivariate Markov switching models, MS-VAR models, leading indicators.