St. Louis FED Recession Model

The St. Louis FED publish a “Markov switching” recession model with rigorous test statistics:

http://research.stlouisfed.org/fred2/series/RECPROUSM156N

fredgraph

Monthly data are also provided, allowing testing with Fama-French benchmark data.  Results from buying and selling at various recession probability levels are shown below.(selecting portfolio with highest annual momentum):

blog figs

Selling when recession probability is greater than 80% is best for returns.  The buy threshold has little effect, possibly because the market recovers before the recession risk subsides.

blog figs

Sharpe is maximized by buying when recession risk is under 30% and selling when risk is greater than 60%.  It makes intuitive sense that investing risk is lowest under those conditions.

AMIBROKER CODE:

Buy = rm <= Optimize(“buy threshold”,30,10,100,10);

Sell = rm >= Optimize(“sell threshold”,60,10,100,10);

PositionScore = IIf(ROC(C,12)>0,ROC(C,12),0);

TRADE HISTORY

Ticker Date Ex. date % chg # bars MAE
s-l 4/1/1975 3/1/1980 110% 60 0.0%
s-l 8/1/1980 9/1/1981 19% 14 0.0%
s-m 2/1/1982 3/1/1982 0% 2 0.0%
s-h 12/1/1982 10/1/1990 181% 95 0.0%
s-h 4/1/1991 3/1/2008 1248% 204 -4.4%
s-h 7/1/2009 1/1/2013 78% 44 0.0%
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7 thoughts on “St. Louis FED Recession Model

    • Yes, the backtests cover that scenario. “Spiking” would equate to a sell threshold of 50 (say), on the surface plots. I have not included holding cash after a sell therefore returns are understated. Sharpe is significantly improved as you can see.

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