Stein-Rule Estimation and Generalized Shrinkage Methods for Forecasting Using Many Predictors
We examine the Stein-rule shrinkage estimator for possible improvements in estimation and forecasting when there are many predictors in a linear time series model. We consider the Stein-rule estimator of Hill and Judge (1987) that shrinks the unrestricted unbiased OLS estimator towards a restricted biased principal component (PC) estimator. Since the Stein-rule estimator combines the OLS and PC estimators, it is a model-averaging estimator and produces a combined forecast. The conditions under which the improvement can be achieved depend on several unknown parameters that determine the degree of the Stein-rule shrinkage. We conduct Monte Carlo simulations to examine these parameter regions. The overall picture that emerges is that the Stein-rule shrinkage estimator can dominate both OLS and principal components estimators within an intermediate range of the signal-to-noise ratio. If the signal-to-noise ratio is low, the PC estimator is superior. If the signal-to-noise ratio is high, the OLS estimator is superior. In out-of-sample forecasting with AR(1) predictors, the Stein-rule shrinkage estimator can dominate both OLS and PC estimators when the predictors exhibit low persistence.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Eric Hillebrand & Huiyu Huang & Tae-Hwy Lee & Canlin Li, 2011. "Using the Yield Curve in Forecasting Output Growth and In?flation," CREATES Research Papers 2012-17, School of Economics and Management, University of Aarhus.
- Todd E. Clark & Michael W. McCracken, 2009.
"Combining Forecasts from Nested Models,"
Oxford Bulletin of Economics and Statistics,
Department of Economics, University of Oxford, vol. 71(3), pages 303-329, 06.
- Todd E. Clark & Michael W. McCracken, 2007. "Combining forecasts from nested models," Finance and Economics Discussion Series 2007-43, Board of Governors of the Federal Reserve System (U.S.).
- Todd E. Clark & Michael W. McCracken, 2006. "Combining forecasts from nested models," Research Working Paper RWP 06-02, Federal Reserve Bank of Kansas City.
- Todd E. Clark & Michael W. McCracken, 2008. "Combining forecasts from nested models," Working Papers 2008-037, Federal Reserve Bank of St. Louis.
- Hill, R.Carter & Judge, George G, 1990. "Improved estimation under collinearity and squared error loss," Journal of Multivariate Analysis, Elsevier, vol. 32(2), pages 296-312, February.
- Bai, Jushan & Ng, Serena, 2008. "Forecasting economic time series using targeted predictors," Journal of Econometrics, Elsevier, vol. 146(2), pages 304-317, October.
- Mittelhammer, Ron C., 1985. "Quadratic risk domination of restricted least squares estimators via Stein-ruled auxiliary constraints," Journal of Econometrics, Elsevier, vol. 29(3), pages 289-303, September.
- Bair, Eric & Hastie, Trevor & Paul, Debashis & Tibshirani, Robert, 2006. "Prediction by Supervised Principal Components," Journal of the American Statistical Association, American Statistical Association, vol. 101, pages 119-137, March.
- Jushan Bai, 2003. "Inferential Theory for Factor Models of Large Dimensions," Econometrica, Econometric Society, vol. 71(1), pages 135-171, January.
- Inoue, Atsushi & Kilian, Lutz, 2005. "How Useful is Bagging in Forecasting Economic Time Series? A Case Study of US CPI Inflation," CEPR Discussion Papers 5304, C.E.P.R. Discussion Papers.
- Fomby, Thomas B & Samanta, Subarna K, 1991. "Application of Stein Rules to Combination Forecasting," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(4), pages 391-407, October.
- Granger, C. W. J., 1980. "Long memory relationships and the aggregation of dynamic models," Journal of Econometrics, Elsevier, vol. 14(2), pages 227-238, October.
- Carter Hill, R. & Judge, George, 1987. "Improved prediction in the presence of multicollinearity," Journal of Econometrics, Elsevier, vol. 35(1), pages 83-100, May.
When requesting a correction, please mention this item's handle: RePEc:aah:create:2012-18. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.