Nowcasting and Forecasting Economic Growth in the Euro Area Using Principal Components

31 Pages Posted: 20 Feb 2014

See all articles by Irma Hindrayanto

Irma Hindrayanto

De Nederlandsche Bank

Siem Jan Koopman

Vrije Universiteit Amsterdam - School of Business and Economics; Tinbergen Institute; Aarhus University - CREATES

Jasper de Winter

De Nederlandsche Bank

Multiple version iconThere are 2 versions of this paper

Date Written: February 19, 2014

Abstract

Many empirical studies show that factor models have a relatively high forecast compared to alternative short-term forecasting models. These empirical findings have been established for different data sets and for different forecast horizons. However, choosing the appropriate factor model specification is still a topic of ongoing debate. Moreover, the forecast performance during the recent financial crisis is not well documented. In this study we investigate these two issues in depth. We empirically test the forecast performance of three factor model approaches and report our findings in an extended empirical out-of-sample forecasting competition for the euro area and its five largest countries over the period 1992-2012. Besides, we introduce two extensions to the existing factor models to make them more suited for real-time forecasting. We show that the factor models were able to systematically beat the benchmark autoregressive model, both before as well as during the financial crisis. The recently proposed collapsed dynamic factor model shows the highest forecast accuracy for the euro area and the majority of countries we analyzed. The improvement against the benchmark model can range up to 77%, depending on the country and forecast horizon.

Keywords: Factor models, Principal component analysis, Forecasting, Kalman filter, State space method, Publication lag, Mixed frequency

Suggested Citation

Hindrayanto, Irma and Koopman, Siem Jan and de Winter, Jasper, Nowcasting and Forecasting Economic Growth in the Euro Area Using Principal Components (February 19, 2014). De Nederlandsche Bank Working Paper No. 415. Available at SSRN: https://ssrn.com/abstract=2398321 or http://dx.doi.org/10.2139/ssrn.2398321

Irma Hindrayanto (Contact Author)

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

Siem Jan Koopman

Vrije Universiteit Amsterdam - School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands
+31205986019 (Phone)

HOME PAGE: http://sjkoopman.net

Tinbergen Institute ( email )

Gustav Mahlerplein 117
1082 MS Amsterdam
Netherlands

HOME PAGE: http://personal.vu.nl/s.j.koopman

Aarhus University - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Jasper de Winter

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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