Yield curve

Abstract

Yield curve represents the graph illustrating yields on bonds with different maturities. Spread is the difference between interest rates on two different maturities (For eg: between Ten-year bond and 3- month bond). Recession is the period during which the economic activity declines and major indices like GDP fall. Several complex mathematical models are used to predict the future business cycles. Several research papers have indicated that simple variables like interest rates, stock market indices, spreads of bonds with different maturities can also serve as indicators of future economic cycles. In this project, we are analyzing the effectiveness of the spread between ten-year US bond and three-month US treasury bill. In this study, initially we tried to study the ability of the spread to predict the future recessions. If spread can predict the recessions effectively, it will be of great use to the policy makers, governments, markets to devise policy decisions that will try to curtail the impact of the recessions. Secondly, we tried to validate our model for out of sample data for periods ahead in addition to the in-sample period.