Business Cycle Recessions Research Articles

Sector Investing Risks in Different Market Conditions

GICS sector investing is a popular investment style that offers increased liquidity and reduced idiosyncratic risk as compared with investing in individual stocks. This is attested by the increase in trading volumes of ETFs tracking GICS sectors. While most investors are aware of macro-economic risks associated with GICS sectors by virtue of industry type constituting the sector, information about the relative performance of sectors in different market environments is not as keenly understood. For example, most investors know that utilities and consumer staples perform well during recessions; but most are unaware of how the sectors perform relative to one another during inflationary periods or during periods of wide credit spreads. Most of the knowledge about relative sector performance is restricted to associating the economic conditions with recessionary or expansionary phases of the business cycle. Further, individual components of certain sectors behave very differently during certain market periods, forming sub-sectors within the sectors. Investors who are focused on positioning their portfolio for certain market environments may find it beneficial to concentrate their holding in that sub-sector to the extent that it meets their growth mandates while staying within risk tolerance. This work presents a detailed comparison of risk and return characteristics of the 11 GICS sectors in five market environments: business-cycle recession, rising interest rates, rising inflation, high market volatility, and wide credit spreads. Further, it dissects the behavior of individual sector components to glean information about when it may be advisable for sector investors to focus on industry groups within sectors. Looking at the current market environment and the likely evolution of macroeconomic conditions in the near future, it extrapolates the findings to make general recommendations for sector investing in the near future.

Research on the new Keynesian and monetarist economists’ responses to the 2008 financial crisis in the USA

This article’s main topic is How New Keynesian and monetary response to most countries’ business cycle recession. The purpose of choosing this topic is to study how new Keynesian and monetarist economists respond to the 2008 financial crisis in the USA by an easy way from definition-model-reality to analyze the question. Using a case study and comparative analysis, this paper research Model explanations of the Great Recession in different methods and causes of the great recession from 2007 to 2009. Moreover, this paper shows that the primary distinction between new Keynesian and monetarist approaches to the Great Recession is the use of the government budget and money supply. Finally, through the data and results this paper obtained, readers may have a clearer understanding of the practicability of these two theories so that they can make a better choice according to the real situation. In addition, it lets the readers understand the question and provide more research information for the researchers in the future.

Oil price volatility predictability: New evidence from a scaled PCA approach

We introduce the scaled principal component analysis (sPCA) method to forecast oil volatility, and compare it with two commonly used dimensionality reduction methods: principal component analysis (PCA) and partial least squares (PLS). By combining the simple autoregressive model with the three dimensionality reduction methods, we obtain several interesting and notable findings. First, the model with the sPCA diffusion index performs substantially better than the competing models based on the out-of-sample Roos2 test. Moreover, the model with the sPCA diffusion index consistently demonstrates superior forecasting power compared with the other models under different macroeconomic conditions (e.g., business cycle recessions and expansions, high- and low-volatility levels, and the COVID-19 pandemic). Furthermore, the findings of our study are strongly robust to various robustness tests, such as alternative forecasting window sizes and different lags of model selection.

Evaluating the OECD’s main economic indicators at anticipating recessions*

AbstractUsing receiver operating characteristic (ROC) techniques, we evaluate the predictive content of the monthly main economic indicators (MEI) of the Organization for Economic Co‐operation and Development (OECD) for predicting both growth cycle and business cycle recessions at different horizons. From a sample that covers 123 indicators for 32 OECD countries as well as for Brazil, China, India, Indonesia, the Russian Federation, and South Africa, our results suggest that the OECD's MEI show a high overall performance in providing early signals of economic downturns worldwide, albeit they perform a bit better at anticipating business cycles than growth cycles. Although the performance for OECD and non‐OECD members is similar in terms of timeliness, the indicators are more accurate at anticipating recessions for OECD members. Finally, we find that some single indicators, such as interest rates, spreads, and credit indicators, perform even better than the composite leading indicators.

Bond vs. bank finance and the Great Recession

The typical increase of the corporate bond-to-bank ratio during downturns is known to mitigate business cycle recessions. In the three longest and deepest post-war U.S. recessions this ratio didn’t increase from their outsets. In this paper we focus on the timing of the corporate bank-to-bond substitution in the Great Recession, simulating counterfactual paths for output growth under plausible notional behaviors of the bond-to-bank ratio. We find that the Great Recession would have been milder and the recovery much stronger if the bank-to-bond substitution had started since the outset of the recession and evolved thereafter as in most U.S. recessions.

Lagged country returns and international stock return predictability during business cycle recession periods

ABSTRACT This study examines stock return predictability in business cycle fluctuations across 17 developed countries and 26 developing countries over the period from January 1970 to December 2019. We uncover that lagged U.S. returns can be regarded as a reliable predictor only during recessions. The results remain robust after controlling for commonly used return predictors. Our empirical findings carry some implications for the role of leading markets, fundamental uncertainty, change in investors’ beliefs and dynamics of stock return volatility in economic downturns.

Bond vs Bank Finance and the Great Recession

The typical increase of the corporate bond-to-bank ratio during downturns is known to mitigate business cycle recessions. In the three longest and deepest post-war U.S. recessions this ratio didn't increase from their outsets. In this paper we focus on the timing of the corporate bank-to-bond substitution in the Great Recession, simulating counterfactual paths for output growth under plausible notional behaviors of the bond-to-bank ratio. We find that the Great Recession would have been milder and the recovery much stronger if the bank-to-bond substitution had started since the outset of the recession and evolved thereafter as in most U.S. recessions.

Volatility spillover from the US to international stock markets: A heterogeneous volatility spillover GARCH model

A recent study by Rapach, Strauss, and Zhou (Journal of Finance, 2013, 68(4), 1633–1662) shows that US stock returns can provide predictive content for international stock returns. We extend their work from a volatility perspective. We propose a model, namely a heterogeneous volatility spillover–generalized autoregressive conditional heteroskedasticity model, to investigate volatility spillover. The model specification is parsimonious and can be used to analyze the time variation property of the spillover effect. Our in‐sample evidence shows the existence of strong volatility spillover from the US to five major stock markets and indicates that the spillover was stronger during business cycle recessions in the USA. Out‐of‐sample results show that accounting for spillover information from the USA can significantly improve the forecasting accuracy of international stock price volatility.

Forecasting US interest rates and business cycle with a nonlinear regime switching VAR model

AbstractThis paper introduces a regime switching vector autoregressive model with time‐varying regime probabilities, where the regime switching dynamics is described by an observable binary response variable predicted simultaneously with the variables subject to regime changes. Dependence on the observed binary variable distinguishes the model from various previously proposed multivariate regime switching models, facilitating a handy simulation‐based multistep forecasting method. An empirical application shows a strong bidirectional predictive linkage between US interest rates and NBER business cycle recession and expansion periods. Due to the predictability of the business cycle regimes, the proposed model yields superior out‐of‐sample forecasts of the US short‐term interest rate and the term spread compared with the linear and nonlinear vector autoregressive (VAR) models, including the Markov switching VAR model.

Parameter uncertainty and inflation dynamics in a model with asymmetric central bank preferences

This paper builds on the Lucas' (1973) signal extraction model to study the time-varying effect of uncertainty in the output-inflation trade-off on inflation, using a monetary model with asymmetric central bank preferences whereby deviations of output (relative to target) from above are weighted differently from deviations from below. The model is investigated empirically using data from the South African Reserve Bank (SARB). We show that the implication of the uncertainty element is to cause the authority to change its indirect control, output by less (and hence change it direct control, interest rate by less) whenever inflation is below or above the target, in line with Brainard's attenuation principle. We also find that SARB's asymmetric output stabilization explains inflation movements significantly, and that the monetary authority seems to be more averse to business cycle recessions than expansions, hence more keen to avoid recessions than expansions. Overall, a more transparent and committed monetary policy practice that would reduce uncertainty over the output-inflation trade-off would be helpful for economic stability.

Changes in CO2 emissions over business cycle recessions and expansions in the United States: A decomposition analysis

This paper examines the asymmetry of changes in CO2 emissions over business cycle recessions and expansions using yearly data from 1949 and monthly data from 1973 for the United States (US). In addition, decomposition analysis is applied to investigate the relative roles of various proximate contributing factors to observed changes in total and per capita CO2 emissions and emissions intensity, over business cycle phases. The results suggest, inter alia, that aggregate emissions and emissions intensity reduce much faster in contractions than they increase in expansions. In addition, unlike the three previous expansions, in the most recent post-GFC US expansion, emissions per capita have continued to decline, and at a rate very similar to the rate of reduction in preceding contractions. This suggests the real possibility that the most recent contraction may have had an ongoing impact on the path of per capita emissions well beyond the immediate impact experienced during the contraction itself.

Higher education's flawed recession response

Purpose – The purpose of this paper is to discuss the reality that recessions experienced by the larger economy also impact the higher education sector, institutional leaders’ failure to prepare for the inevitable and to introduce proactive steps that should be considered. Design/methodology/approach – The author notes that while recessions cannot be accurately predicted, they are inevitable. Without anticipating and preparing for the inevitable revenue shortfall institutional responses tend to be reactive and too often draconian. Findings – Yet, institutions routinely prepare for a broad array of liabilities that occur far less frequently. Failing to recognize the inevitability of the next recession and to prepare for its uncertain arrival is a neglect of fiduciary responsibility. To prepare for the inevitable, institutional leaders are encouraged to ask five fundamental questions to minimize the future need to make draconian budget cuts. Research limitations/implications – There is a literature gap in the failure to recognize the individual and institutional damage resulting from reactive responses to the business cycle's recession phase. Practical implications – As the business cycle's Great Recession of 2008 enters its recovery, phase institutional leaders will have an opportunity to prepare for the next unavoidable recession. Scholars will have accompanying opportunities to track the success or failures of their preparations when the next recession materializes. Originality/value – The higher education sector's vulnerability and lack of preparedness has largely gone unnoticed. Proactive preparation, rather than reactive, responses are needed to minimize damage to the institution, its students, faculty and staff.

The Current Economic Crisis in the United States

This paper offers an analysis of the current economic crisis in the United States that began in 2008, which is understood not as a business cycle recession but as a structural crisis. It presents a case that the current economic crisis is a particular type of crisis of over-investment, called an asset bubble induced over-investment crisis. It explains what is meant by that type of crisis and presents empirical evidence for the period since 1979 that supports this interpretation of the crisis. It argues that the forces that led to the current crisis cannot be seen in the behavior of the rate of profit. JEL Classification: E11, E32, N12

A BIVARIATE AUTOREGRESSIVE PROBIT MODEL: BUSINESS CYCLE LINKAGES AND TRANSMISSION OF RECESSION PROBABILITIES

I propose a new binary bivariate autoregressive probit model of the state of the business cycle. This model nests various special cases, such as two separate univariate probit models used extensively in the previous literature. The parameters are estimated by the method of maximum likelihood and forecasts can be computed by explicit formulae. The model is applied to predict the U.S. and German business cycle recession and expansion periods. Evidence of in-sample and out-of-sample predictability of recession periods by financial variables is obtained. The proposed bivariate autoregressive probit model allowing links between the recession probabilities in the United States and Germany turns out to outperform two univariate models.

Public Debt Overhangs: Advanced-Economy Episodes Since 1800

We identify the major public debt overhang episodes in the advanced economies since the early 1800s, characterized by public debt to GDP levels exceeding 90 percent for at least five years. Consistent with Reinhart and Rogoff (2010) and most of the more recent research, we find that public debt overhang episodes are associated with lower growth than during other periods. The duration of the average debt overhang episode is perhaps its most striking feature. Among the 26 episodes we identify, 20 lasted more than a decade. The long duration belies the view that the correlation is caused mainly by debt buildups during business cycle recessions. The long duration also implies that the cumulative shortfall in output from debt overhang is potentially massive. These growth-reducing effects of high public debt are apparently not transmitted exclusively through high real interest rates, as in eleven of the episodes, interest rates are not materially higher.

Financial assets, linear and nonlinear policy rules

PurposeThe purpose of this paper is to investigate how the South African Reserve Bank (SARB) sets monetary policy rate.Design/methodology/approachGiven the controversial debate on whether central banks should target asset prices for economic stability, the authors analyse whether the SARB policy‐makers pay close attention to asset and financial markets in its policy decisions in the context of both linear and nonlinear Taylor type rule models of monetary policy.FindingsThe main findings are that the nonlinear Taylor rule provides the best description of in‐sample SARB interest rate setting behaviour as the financial crisis unfolds. The SARB policy‐makers pay close attention to the financial conditions index when setting interest rates. The SARB's response of monetary policy to inflation is greater during business cycle recessions with not much weight on output and seems to place high importance on inflationary pressures of output during boom periods. The 2007‐2009 financial crisis witnesses an overall decreased reaction to inflation, output and financial conditions amidst increased economic uncertainty.Originality/valueThis paper introduces a financial condition index into a Taylor monetary policy rule and examines whether nonlinear models can provide additional information over a linear model.

Predicting Market Components Out of Sample: Asset Allocation Implications

The authors analyze out-of-sample return predictability for components of the aggregate market, focusing on the well-known Fama–French size/value-sorted portfolios. Employing a forecast combination approach based on a variety of economic variables and lagged component returns as predictors, they find significant evidence of out-of-sample return predictability for nearly all component portfolios. Moreover, return predictability is typically much stronger for small-cap/high book-to-market value stocks. The pattern of component return predictability is enhanced during business cycle recessions, linking component return predictability to the real economy. Considering various component-rotation investment strategies, the authors show that out-of-sample component return predictability can be exploited to substantially improve portfolio performance.

Optimal monetary policy reaction function in a model with target zones and asymmetric preferences for South Africa

This paper estimates the optimal response of the SARB to deviations of inflation and output from their target values over the inflation targeting era. This is achieved using an empirical framework that allows the central bank's policy preferences to be zone-like and asymmetric. The first major finding is that the monetary authorities' response towards inflation is zone symmetric. That is, they react in a passive manner when inflation is within the target band whereas they become increasingly aggressive when it deviates from the target band. The monetary authorities also react with the same level of aggressiveness regardless of whether inflation overshoots or undershoots the inflation target band. The second major finding is that the monetary authorities' response to output fluctuations is asymmetric. That is, they react more aggressively to negative deviations of output from the potential so that they weigh business cycle recessions more than expansions.

A Markov Switching Regime Model of the Brazilian Business Cycle

Previous studies have shown that linear models are incapable of capturing business cycle dynamics with accuracy. This has brought interest in non-linear models such as the Markov switching (MS) regime technique, which can distinguish business cycle recession and expansion phases, and is sufficiently flexible to allow different relationships to apply over these phases. This technique can be used to simultaneously estimate the data generating process of real GDP growth and classify each observation into one of two regimes (i.e. low-growth and high-growth regimes). In this study, we investigate the dynamics of the Brazilian business cycle using a Markov regime switching vector autoregressive model (MS-VAR). The study was developed using time-variable transition probabilities (TVTP) and for comparison and validation, fixed transition probabilities (FTP) between regimes. In order to capture cyclical fluctuations of the Brazilian GDP, we use the yield spread as a leading indicator. Most of the results obtained with the MS-VAR-TVTP are according to the expected. We show that the model is adequate to predict short-term cyclical fluctuations in the Brazilian economy. We also estimate an MS-VAR model with FTP in order to validate the TVTP model. We confirm the relevance of the yield spread in the estimation of the model parameters and the transition probabilities.

A multi‐level panel STAR model for US manufacturing sectors

AbstractWe introduce a multi‐level smooth transition model for a panel of time series, which can be used to examine the presence of common nonlinear business cycle features across many variables. The model is positioned in between a fully pooled model, which imposes such common features, and a fully heterogeneous model, which allows for unrestricted nonlinearity. We introduce a second‐stage model linking the parameters that determine the timing of the switches between business cycle regimes to observable explanatory variables, thereby allowing for lead–lag relationships across panel members. We discuss representation, estimation by concentrated simulated maximum likelihood and inference. We illustrate our model using quarterly industrial production in 19 US manufacturing sectors, and document that there are subtle differences across sectors in leads and lags for switches between business cycle recessions and expansions. Copyright © 2005 John Wiley & Sons, Ltd.