A Frequency Based Causality Approach For The Yield Spread As A Leading Indicator Of Economic Activity - Evidence From India

Abstract

The predictive power of yield spreads constructed at the various ends of the yield curve is tested using Granger causality approach. Since we fail to find any predictive information in the yield spreads by this approach, an alternative methodology of frequency based causality by Breitung and Candelon (2006) is employed. Consistent with the theory, we find evidence of predictive information in the yield spreads constructed at the policy relevant area of the yield curve only. Whi/,e the yield spreads constructed at the longer end of the yield curve do not seem to have predictive information, the yield spreads constructed at the shorter end of the yield curve indicate predictive information at limited frequencies. Our results further indicate that only lower frequencies of policy relevant horizon yield spreads have predictive information and higher frequencies could be the reason for distorting the predictive information in the yield spread.