A tale of two recession-derivative indicators

Two recession-derivative indicators (RDIs) have been used extensively as forecast objects in business cycle prediction, viz. (1) the target variable takes value 1 if there is a recession starting exactly at a specific horizon in the future, and (2) the target variable takes value 1 if there is a recession starting any time over a specified period in the future. Using daily yield spread as an illustrative predictor, we formally and quantitatively compare the two RDIs using the receiver operating characteristics analysis. Over 1962–2021 covering eight NBER recessions, we find that generally the second RDI, ceteris paribus, will make the the predictor better performing. However, the first RDI can generate better-looking and more useful predictions under certain scenarios, depending on forecast horizon, recession duration and time profile of signals. We also consider a semiannual chronology proposed by Peláez (J Macroecon 45:384–393, 2015) and find that its performance is in the middle of the other two. Our analysis suggests that the choice of a particular RDI should be dictated by the needs of forecast user in a particular decision making context.