Date of Graduation

5-2014

Document Type

Thesis

Degree Name

Bachelor of Science in Biological Engineering

Degree Level

Undergraduate

Department

Finance

Advisor

Rennie, Craig G.

Reader

Santamaria, Sergio F

Abstract

For decades, many financial economists have suspected that an inverted yield curve predicts recession. This paper explores the accuracy of this belief by testing multiple variables and seeing if they result in a recession. The dependent variable tested is probability of a recession; independent variables tested are: three-month Treasury-bill minus ten-year Treasury note; controls include: three-month Treasury-bill yield to maturity, ten-year Treasury-note yield to maturity, number of months since last recession, equal-weighted return on the S&P 500, value-weighted return minus equal-weighted return, return on the S&P 500, rate of inflation, and the interaction between the difference between the three-month Treasury-bill and the ten-year Treasury-note. The null hypothesis is that there is no relationship between the variables and the likelihood of a recession. Failing to reject the null illustrates that there is a relationship between the inverted yield curve and the likelihood of a recession. Using logistic regression models, I find that when the previous month is not part of a recession, we fail to reject the null hypothesis because there is a relationship between the inverted yield curve and the likelihood of a recession. Consequently, the inverted yield curve is like ‘famine, the third horsemen of the apocalypse.’ My model shows that all the other variables are significant in revealing that the inverted yield curve is not the only predictor of a recession.

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