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Forecasting with Approximate Dynamic Factor Models: the Role of Non-Pervasive Shocks

  • Matteo Luciani

This paper studies the role of non-pervasive shocks when forecasting with factor models. To this end, we first introduce a new model that incorporates the effects of non-pervasive shocks, an Approximate Dynamic Factor Model with a sparse model for the idiosyncratic component. Then, we test the forecasting performance of this model both in simulations, and on a large panel of US quarterly data. We find that, when the goal is to forecast a disaggregated variable, which is usually affected by regional or sectorial shocks, it is useful to capture the dynamics generated by non-pervasive shocks; however, when the goal is to forecast an aggregate variable, which responds primarily to macroeconomic, i.e. pervasive, shocks, accounting for non-pervasive shocks is not useful.

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File URL: https://dipot.ulb.ac.be/dspace/bitstream/2013/97308/1/2011-022-LUCIANI_forecasting.pdf
File Function: 2011-022-LUCIANI_forecasting
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Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers ECARES with number ECARES 2011‐022.

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Length: 10 p.
Date of creation: Jul 2011
Date of revision:
Publication status: Published by: Elsevier, International Journal of Forecasting
Handle: RePEc:eca:wpaper:2013/97308
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