PREDICTION OF RECESSION

The purpose of our research is to examine the predictive power of inverted yield curve for the recession in the near future. The data used in this research are between Jan 1, 1959 to Nov, 2008. There are 8 recessions during this period, including current one. We conducted two sets of tests. The first set consists of spread between 10-year Treasury bond and 3-month Treasury bill and spread between 10-year Treasury bond and 3-month LIBOR; and we find the predictive power of spread between 10-year Treasury bond and 3-month Treasury bill is much stronger than the other one. The second set consists of spread between 10-year SWAP rate and 3-month LIBOR, spread between 10-year Treasury bond and 3-month Treasury bill, as well as the spread between 10-year Treasury bond and 3 month LIBOR. For the second test, we find that although there is a couple of recession involved and data is relatively limited, predictive power of spread between 10-year T-bond and 3 month still stands out and we also find the spread between 3-month LIBOR and 10-year SWAP could be a better indicator in the future by using more data. We conclude that term spread of Treasury rate is still the most powerful tool for forecasting the recession.