Do Eurozone yield spreads predict recessions?

An OLS and probit framework is used to examine the predictive power of yield spreads with respect to GDP growth and recessions in the Eurozone from the 1990s to the recent past. Credit default swap (CDS) data on sovereign bonds, which provide a direct measure of default risk, are employed as part of a new risk-adjustment method that significantly enhances the predictive accuracy of the yield-spread approach. The results show that the accuracy of predictions of growth and recessions using the commonly employed yield spread remains high, provided that biases associated with Eurozone sovereign default risk are accounted for.