How successful are dynamic factor models at forecasting output and inflation? A meta-analytic approach

Sandra Eickmeier and Christina Ziegler
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Sandra Eickmeier: Deutsche Bundesbank, Economic Research Centre, Frankfurt am Main and University of Cologne, Germany, Postal: Deutsche Bundesbank, Economic Research Centre, Frankfurt am Main and University of Cologne, Germany
Christina Ziegler: University of Leipzig and Ifo Institute for Economic Research, Munich, Germany, Postal: University of Leipzig and Ifo Institute for Economic Research, Munich, Germany

Journal of Forecasting, 2008, vol. 27, issue 3, pages 237-265

Abstract: This paper uses a meta-analysis to survey existing factor forecast applications for output and inflation and assesses what causes large factor models to perform better or more poorly at forecasting than other models. Our results suggest that factor models tend to outperform small models, whereas factor forecasts are slightly worse than pooled forecasts. Factor models deliver better predictions for US variables than for UK variables, for US output than for euro-area output and for euro-area inflation than for US inflation. The size of the dataset from which factors are extracted positively affects the relative factor forecast performance, whereas pre-selecting the variables included in the dataset did not improve factor forecasts in the past. Finally, the factor estimation technique may matter as well. Copyright © 2008 John Wiley & Sons, Ltd.

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