Factor forecasts for the UK

Factor forecasts for the UK

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Article ID: iaor2008584
Country: United Kingdom
Volume: 24
Issue: 4
Start Page Number: 279
End Page Number: 298
Publication Date: Jul 2005
Journal: International Journal of Forecasting
Authors: , ,
Keywords: economics
Abstract:

Data are now readily available for a very large number of macroeconomic variables that are potentially useful when forecasting. We argue that recent developments in the theory of dynamic factor models enable such large data sets to be summarized by relatively few estimated factors, which can then be used to improve forecast accuracy. In this paper we construct a large macroeconomic data set for the UK, with about 80 variables, model it using a dynamic factor model, and compare the resulting forecasts with those from a set of standard time-series models. We find that just six factors are sufficient to explain 50% of the variability of all the variables in the data set. These factors can be shown to be related to key variables in the economy, and their use leads to considerable improvements upon standard time-series benchmarks in terms of forecasting performance.

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