Evaluating Factor Models: An Application to Forecasting Inflation in Canada

Marc-André Gosselin and Greg Tkacz ()

Staff Working Papers from Bank of Canada

Abstract: This paper evaluates the forecasting performance of factor models for Canadian inflation. This type of model was introduced and examined by Stock and Watson (1999a), who have shown that it is quite promising for forecasting U.S. inflation. Using a dimension-reduction method similar to traditional principal-components analysis, we extract a small number of factors from a sample consisting of both Canadian and U.S. data and construct four different factor models. Using parametric and non-parametric tests, we compare the forecasting performance of the factor models to various benchmark forecasting models. We conclude that factor models are as good as more elaborate models in forecasting Canadian inflation. Moreover, we find evidence that a model estimated using only U.S. data is helpful in predicting changes in the Canadian inflation rate.

Keywords: Inflation and prices; Econometric and statistical methods (search for similar items in EconPapers)
JEL-codes: C32 E37 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2001
New Economics Papers: this item is included in nep-cba, nep-ecm and nep-mac
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Citations: View citations in EconPapers (31)

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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:01-18

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