Abstract
The leading indicator ability of yield spread for future output growth and inflation is tested for India. Using the yields on securities with maturities ten years and three months to construct yield spread, we study the predictive power of yield spread for output growth and inflation. Our results based on regression of future inflation and output on yield spreads indicate that there is no information in the yield spread about future economic activity and inflation in India. Further, the predictive power of yield spread is analyzed over different quantiles of inflation and output growth using quantile regression; we find that there is again no evidence of predictive information in the yield spreads. Using multiscale wavelet based regression, predictive power is however unveiled at higher time scales for output growth only.
Highlights
A large body of literature on the role of asset prices— including interest rates, stock returns, dividend yields, and exchange rates—as predictors of inflation and growth is large and clearly of interest to consumers, investors, and policy makers
The yield spread has been found very useful for forecasting financial variables such as output growth, inflation, industrial production, consumption, and recessions, and the ability of the spread to predict economic activity has become something of a stylized fact among macroeconomists
We used conventional ordinary least squares to study the leading indicator property of yield spread for inflation and output growth in India
Summary
A large body of literature on the role of asset prices— including interest rates, stock returns, dividend yields, and exchange rates—as predictors of inflation and growth is large and clearly of interest to consumers, investors, and policy makers. Many empirical studies find yield spread as a good predictor of economic activity and inflation, some studies reveal either no or very weak predictive content of yield spread (see [19, 20]) This lack of predictive ability has been attributed to several reasons; for example, heavy financial regulation by governments may not bring expectations into interest rates and yield spreads may not contain information for predicting economic activity and inflation, asymmetric monetary policy [18], negligence of taking into account structural breaks in relationships [21], and time varying term premium which have been found to diminish the predictive power of yield spreads [22]. We assess the leading indicator property of yield spread at different frequencies of output growth and inflation in India using the multiscale regression based on wavelets. The data description and the results of this analysis are discussed in Section 5 and Section 6 gathers the main conclusions
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