Recessions in Portugal: the predictive power of term structure of interest rates components

Abstract

In this paper we present a study of the predictive ability of the term structure of interest rates over future recessions in Portugal. The analysis will be based on factor models in which the term structure of interest rates is determined by latent factors, corresponding to their level, slope and curvature. Simple and modified probit and logit models will be used to examine the forecasting ability of term structure in predicting economic crises (recessions). Recession periods were determined based on the methodology proposed by Bry and Boschan. Our results suggest that all term structure of interest rates components allow to predict recessions in one-year time horizons, with an increase in adjustment quality when we include an autoregressive term as the explanatory variable.