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

Tinbergen Institute Discussion Paper 14-113/III

29 Pages Posted: 24 Aug 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: August 20, 2014

Abstract

Many empirical studies have shown that factor models produce relatively accurate forecasts compared to alternative short-term forecasting models. These empirical findings have been established for different macroeconomic data sets and different forecast horizons. However, various specifications of the factor model exist and it is a topic of debate which specification is most effective in its forecasting performance. Furthermore, the forecast performances of the different specifications during the recent financial crisis are also not well documented. In this study we investigate these two issues in depth. We empirically verify the forecast performance of three factor model approaches and report our findings in an extended empirical out-of-sample forecasting competition for quarterly growth of gross domestic product in the euro area and its five largest countries over the period 1992-2012. We also introduce two extensions of existing factor models to make them more suitable for real-time forecasting. We show that the factor models have been 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 that we have analyzed. The forecast precision improvements against the benchmark model can range up to 77% in mean square error reduction, depending on the country and forecast horizon.

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

JEL Classification: C32, C53, E17

Suggested Citation

Hindrayanto, Irma and Koopman, Siem Jan and de Winter, Jasper, Nowcasting and Forecasting Economic Growth in the Euro Area Using Principal Components (August 20, 2014). Tinbergen Institute Discussion Paper 14-113/III. Available at SSRN: https://ssrn.com/abstract=2485279 or http://dx.doi.org/10.2139/ssrn.2485279

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

Register to save articles to
your library

Register

Paper statistics

Downloads
30
Abstract Views
357
PlumX Metrics