Indexed on: 17 Mar '16Published on: 23 Feb '16Published in: Journal of Econometrics
This paper derives new theoretical results for forecasting with Global VAR (GVAR) models. It is shown that the presence of strong unobserved common factors can lead to an undetermined GVAR model. To solve this problem, we propose augmenting the GVAR with additional proxy equations for the strong factors and establish conditions under which forecasts from the augmented GVAR model (AugGVAR) uniformly converge in probability (as the panel dimensions <img height="22" border="0" style="vertical-align:bottom" width="71" alt="View the MathML source" title="View the MathML source" src="http://origin-ars.els-cdn.com/content/image/1-s2.0-S0304407616300069-si148.gif">N,T→j∞) to the infeasible optimal forecasts obtained from a factor-augmented high-dimensional VAR model. The small sample properties of the proposed solution are investigated by Monte Carlo experiments as well as empirically. In the empirical part, we investigate the value of the information content of Purchasing Managers’ Indices (PMIs) for forecasting global (48 countries) output growth, and compare forecasts from AugGVAR models with a number of data-rich forecasting methods, including Lasso, Ridge, partial least squares, and factor-based techniques. It is found that (a) regardless of the forecasting methods considered, PMIs are useful for nowcasting, but their value added diminishes quite rapidly with the forecast horizon, and (b) AugGVAR forecasts do as well as other data-rich forecasting techniques for short horizons, and tend to do better for longer forecast horizons.