How do binary models that predict recessions compare with models that forecast continuous dependent variables (e.g., real GDP or industrial production growth)?
A. These two types of models may be compared in two dimensions: accuracy and robustness. There is evidence that the most accurate binary models perform about as well as the most accurate continuous models. For example, Estrella and Hardouvelis (1991) and Estrella and Mishkin (1997) find that the R-squared in models of cumulative GNP growth is similar in magnitude to the pseudo R-squared in probit models of recession. The sample period may influence the results somewhat, particularly in the case of the continuous models. Stock and Watson (2003) find substantial evidence of instability over time in various models of output growth, and Estrella, Rodrigues and Schich (2003) find some instability in models of industrial production growth. However, the latter paper suggests that binary models of recessions are quite robust over time, both in Germany and in the United States.
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