The Generalized Dynamic Factor Model: One-Sided Estimation and Forecasting

30 Pages Posted: 13 Aug 2002  

Mario Forni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics; Centre for Economic Policy Research (CEPR)

Marc Hallin

ECARES, Universite Libre de Bruxelles

Marco Lippi

Dipartimento di Scienze Economiche (DiSSE); Einaudi Institute for Economics and Finance (EIEF)

Lucrezia Reichlin

London Business School; Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES); Centre for Economic Policy Research (CEPR); European Central Bank (ECB)

Date Written: June 2002

Abstract

This Paper proposes a new forecasting method that exploits information from a large panel of time series. The method is based on the generalized dynamic factor model proposed in Forni, Hallin, Lippi, and Reichlin (2000), and takes advantage of the information on the dynamic covariance structure of the whole panel. We first use our previous method to obtain an estimation for the covariance matrices of common and idiosyncratic components. The generalized eigenvectors of this couple of matrices are then used to derive a consistent estimate of the optimal forecast, which is constructed as a linear combination of present and past observations only (one-sided filter). This two-step approach solves the end-of-sample problems caused by two-sided filtering (as in our previous work), while retaining the advantages of an estimator based on dynamic information. Both simulation results and an empirical illustration on the forecast of the Euro area industrial production and inflation, based on a panel of 447 monthly time series show very encouraging results.

Keywords: Dynamic factor models, principal components, time series, large cross-sections, panel data, forecasting

JEL Classification: C13, C33, C43

Suggested Citation

Forni, Mario and Hallin, Marc and Lippi, Marco and Reichlin, Lucrezia, The Generalized Dynamic Factor Model: One-Sided Estimation and Forecasting (June 2002). CEPR Discussion Paper No. 3432. Available at SSRN: https://ssrn.com/abstract=323387

Mario Forni (Contact Author)

Università degli studi di Modena e Reggio Emilia (UNIMORE) - Faculty of Business and Economics ( email )

Viale Berengario 51
41100 Modena, Modena 41100
Italy
+39 059 205 6852 (Phone)
+39 059 205 6947 (Fax)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Marc Hallin

ECARES, Universite Libre de Bruxelles ( email )

Ave. Franklin D Roosevelt, 50 - C.P. 114
Brussels, B-1050
Belgium
+32 2 650 5886 (Phone)
+32 2 650 5899 (Fax)

Marco Lippi

Dipartimento di Scienze Economiche (DiSSE) ( email )

14 Via Cesalpino
Rome, 00161
Italy
+39 06 4428 4202 (Phone)
+39 06 4404 572 (Fax)

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

Lucrezia Reichlin

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES) ( email )

Ave. Franklin D Roosevelt, 50 - C.P. 114
Brussels, B-1050
Belgium
+32 2 650 4221 (Phone)
+32 2 650 4475 (Fax)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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