An Index of Uncertainty for Business Cycle Leading Indicators

Leading indicators based on correlations with reference cycles are regularly used to monitor the economy. It would be useful if we could have a quantitative measure of the risk associated with leading indicators forecasts. In this paper, we outline a methodology to develop an index for quantifying the risk of the economy actually ending up in a boom when the indicator/index predicts recession and vice-a-versa. These measures will be particularly useful for analyzing turning points, where leading indicator forecasts are at the greatest risk of going wrong. The paper carries out one exercise as an illustration and demonstrates the close correspondence between the risk function (determined in advance) and the turning points of the business cycle.