The Unemployment Forecast (Bond Premium Model)
The Unemployment Forecast (AR1 Model)
Given that the current unemployment rate is 8.5, our current forecast implies a 10.5% unemployment rate in March 2010.
Some comments:
The data are monthly and start in 1973 and end in 2008:12.
The bond premium is constructed as a residual from a regression of bond spreads on the individual components that are used to measure distance-to-default in a Merton Model. The regression also includes bond ratings. The regression is estimated at the issue level. The errors are then averaged within each time period.
The unemployment forecast for the bond premium model is obtained from a regression of the year-over-year change in unemployment on the bond premium:
U(t)-U(t-12) = c(0) + c(1)Bond_Premium(t-12) + e(t)
The estimated values are: c(0) = -1.57, c(1) = 1.07
If the bond premium is 1 percentage point above its long run value, the unemployment rate is predicted to increase 1.07 percentage points over the coming year.
The AR1 model simply regresses the unemployment rate at t on the its lagged value at time t-12.