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A dynamic factor model for the Mexican economy: are common trends useful when predicting economic activity?

Author

Listed:
  • Francisco Corona

    () (Universidad Carlos III de Madrid)

  • Graciela González-Farías

    () (Centro de Investigación en Matemáticas, A.C.)

  • Pedro Orraca

    () (El Colegio de la Frontera Norte)

Abstract

Abstract In this paper we propose to use the common trends of the Mexican economy in order to predict economic activity one and two steps ahead. We exploit the cointegration properties of the macroeconomic time series, such that, when the series are I(1) and cointegrated, there is a factor representation, where the common factors are the common trends of the macroeconomic variables. Thus, we estimate a large non-stationary dynamic factor model using principal components (PC) as suggested by Bai (J Econom 122(1):137–183, 2004), where the estimated common factors are used in a factor-augmented vector autoregressive model to forecast the Global Index of Economic Activity. Additionally, we estimate the common trends through partial least squares. The results indicate that the common trends are useful to predict Mexican economic activity, and reduce the forecast error with respect to benchmark models, mainly when estimated using PC.

Suggested Citation

  • Francisco Corona & Graciela González-Farías & Pedro Orraca, 2017. "A dynamic factor model for the Mexican economy: are common trends useful when predicting economic activity?," Latin American Economic Review, Springer;Centro de Investigaciòn y Docencia Económica (CIDE), vol. 26(1), pages 1-35, December.
  • Handle: RePEc:spr:laecrv:v:26:y:2017:i:1:d:10.1007_s40503-017-0044-7
    DOI: 10.1007/s40503-017-0044-7
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    References listed on IDEAS

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    Cited by:

    1. Bhattacharya, Rudrani & Chakravarti, Parma & Mundle, Sudipto, 2018. "Forecasting India's Economic Growth: A Time-Varying Parameter Regression Approach," Working Papers 18/238, National Institute of Public Finance and Policy.

    More about this item

    Keywords

    Dynamic factor models; Common trends; Factor-augmented vector autoregressive model; Partial least squares; Forecast error;

    JEL classification:

    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E00 - Macroeconomics and Monetary Economics - - General - - - General

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