The time-varying leading properties of the high yield spread in the United States

We propose a comprehensive empirical examination of the time-varying leading properties of two high yield spreads in the United States, and compare them with the leading properties of the term spread between the mid-1980s and the end of 2011. In a large set of in-sample and out-of-sample forecast exercises, we show that high yield spreads are not reliable predictors of future economic activity, as measured by the real gross domestic product and industrial production. Their predictive content for economic growth, which is statistically and economically significant between the end of the 1980s and the beginning of the new century, vanishes in the second half of the 2000s. This disappearance is coincident with (i) structural breaks in the relationship, which largely occurred in the early years of the past decade and during the 2007-2009 financial crisis, and (ii) the reappearance of the leading properties of the term spread in recent years. In general, despite the recent deterioration of much of their predictive content, high yield spreads still tend to outperform the term spread for predicting economic growth at horizons of up to one year in both the in-sample and out-of-sample exercises, even after accounting for time-varying parameters in the model specifications.