Forecasting in Dynamic Factor Models Subject to Structural Instability

James H. Stock, Mark W. Watson

Research output: Chapter in Book/Report/Conference proceedingChapter

62 Scopus citations

Abstract

This chapter assesses forecasts constructed using dynamic factor models for their reliability in the face of structural breaks. Dynamic factor models have had notable empirical forecasting successes, but there has been little work to date on the performance of factor-based macroeconomic forecasts under structural instability. In factor models, even if factor loadings are unstable, if the instability is sufficiently independent across series then the estimated factors could be well estimated even if individual relations between the observable series and the factors are unstable. This chapter first lays out the implications for forecasting of different types of structural instability in dynamic factor models, provides a new empirical investigation (using US data for 144 quarterly macroeconomic time series) of factor-based forecasting with potential instability, and investigates separately the effects of structural change on the estimation of the factors and on the use of those factors for forecasting.

Original languageEnglish (US)
Title of host publicationThe Methodology and Practice of Econometrics
Subtitle of host publicationA Festschrift in Honour of David F. Hendry
PublisherOxford University Press
ISBN (Electronic)9780191717314
ISBN (Print)9780199237197
DOIs
StatePublished - Sep 1 2009

All Science Journal Classification (ASJC) codes

  • Economics, Econometrics and Finance(all)

Keywords

  • Dynamic factor models
  • Factor loadings
  • Instability
  • Structural breaks
  • Time-varying factor models

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    Stock, J. H., & Watson, M. W. (2009). Forecasting in Dynamic Factor Models Subject to Structural Instability. In The Methodology and Practice of Econometrics: A Festschrift in Honour of David F. Hendry Oxford University Press. https://doi.org/10.1093/acprof:oso/9780199237197.003.0007