2/2008 Christian Schulz. Forecasting economic activity for Estonia: The application of dynamic principal components analysis

Working Papers of Eesti Pank. No 2/2008

In this paper, the dynamic common factors method of Forni et al. (2000) is applied to a large panel of economic time series on the Estonian economy. In order to improve forecasting of economic activity in Estonia, we derive a leading indicator composed of the common components of twelve series, which were identified as leading. The resulting indicator performs better than two other indicators, which are based on a small-scale state-space model used by Stock and Watson (1991) and a large-scale static principal components model used by Stock and Watson (2002), respectively. It also clearly outperforms the naïve benchmark in both in-sample and out-of-sample forecast comparisons.
JEL Code: C32, C33, C53, E37
Key words: Estonia, forecasting, turning points, dynamic factor models, dynamic principal components, forecast performance

Author's e-mail address: Schulz.Christian [at] bcg.com

The views expressed are those of the author and do not necessarily represent the official views of Eesti Pank.

Contents

1. Introduction
2. Literature review
3. Empirical framework
4. The Estonian Data Set
5. Forecasting Economic Growth for Estonia
6. Conclusions
References
Appendix 1. Data Set and Sources and Cross-correlation with Respect to the Reference Series

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