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Forecasting the Estonian rate of inflation using factor models

Author

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  • Nicolas Reigl

    ()

Abstract

The paper presents forecasts of the headline and core inflation in Estonia with factor models in a recursive pseudo out-of-sample framework. The factors are constructed with a principal component analysis and are then incorporated into vector autoregressive forecasting models. The analyses show that certain factor-augmented vector autoregressive models improve upon a simple univariate autoregressive model but the forecasting gains are small and not systematic. Models with a small number of factors extracted from a large dataset are best suited for forecasting headline inflation. In contrast models with a larger number of factors extracted from a small dataset outperform the benchmark model in the forecast of Estonian headline and, especially, core inflation

Suggested Citation

  • Nicolas Reigl, 2016. "Forecasting the Estonian rate of inflation using factor models," Bank of Estonia Working Papers wp2016-8, Bank of Estonia, revised 10 Oct 2016.
  • Handle: RePEc:eea:boewps:wp2016-8
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    File URL: http://www.eestipank.ee/en/publication/working-papers/2016/82016-nicolas-reigl-forecasting-estonian-rate-inflation-using-factor-models
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    More about this item

    Keywords

    Factor models; factor-augmented vector autoregressive models; factor analysis; principal components; inflation forecasting; forecast evaluation; Estonia;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • 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

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