Title: Modeling of economic and financial conditions for nowcasting and forecasting recessions: A unified approach
Authors: Cem Cakmakli - Koc University (Turkey) [presenting]
Hamza Demircan - KOC University (Turkey)
Sumru Altug - American University of Beirut (Lebanon)
Abstract: A unified framework is proposed for the joint estimation of the indexes that can broadly capture economic and financial conditions together with their cyclical regimes of recession and expansion. Specifically, we utilize a dynamic factor model together with (Markov) regime-switching model parameters that exploit the temporal link between the cyclical behavior of economic and financial factors. This is achieved by constructing the cycle in the financial factor using the cycle in the economic factor together with phase shifts. The resulting framework allows the financial cycle to potentially lead/lag the business cycle systematically and exploits the information in economic and financial variables for estimation of both economic and financial conditions as well as their cyclical behavior efficiently. We examine the potential of the model using a mixed frequency ragged-edge dataset for Turkey. Comparison with conventional competitors reveals that the proposed specification provides precise estimates of economic and financial conditions and it delivers quite accurate probabilities of recessions. We further conduct a recursive real-time exercise of now/forecasting business cycle turning points. The results show convincing evidence of superior predictive power of our specification by signaling oncoming recessions (expansions) as early as 3.5 (3.4) months ahead of the actual realization.