A Multi-Country Approach to Forecasting Output Growth Using PMIs
59 Pages Posted: 24 Nov 2014
Date Written: November 10, 2014
This paper derives new theoretical results for forecasting with Global VAR (GVAR) models. It is shown that the presence of a strong unobserved common factor can lead to an undetermined GVAR model. To solve this problem, we propose augmenting the GVAR with additional proxy equations for the strong factors and establish conditions under which forecasts from the augmented GVAR model (AugGVAR) uniformly converge in probability (as the panel dimensions N,T →┴i ∞ such that N/T → k for some 0 < k < ∞) to the infeasible optimal forecasts obtained from a factor-augmented high-dimensional VAR model. The small sample properties of the proposed solution are investigated by Monte Carlo experiments as well as empirically. In the empirical part, we investigate the value of the information content of Purchasing Managers Indices (PMIs) for forecasting global (48 countries) growth, and compare forecasts from Aug-GVAR models with a number of data-rich forecasting methods, including Lasso, Ridge, partial least squares and factor-based methods. It is found that (a) regardless of the forecasting methods considered, PMIs are useful for nowcasting, but their value added diminishes quite rapidly with the forecast horizon, and (b) AugGVAR forecasts do as well as other data-rich forecasting techniques for short horizons, and tend to do better for longer forecast horizons.
Keywords: Global VARs, High-dimensional VARs, Augmented GVAR, Forecasting, Nowcasting, Data-rich methods, GDP, PMIs
JEL Classification: C53, E37
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