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Keywords:

  • factor models;
  • forecasting;
  • nonlinear

ABSTRACT

Using factors in forecasting exercises reduces the dimensionality of the covariates set and, therefore, allows the forecaster to explore possible nonlinearities in the model. For an American macroeconomic dataset, I present evidence that the employment of nonlinear estimation methods can improve the out-of-sample forecasting accuracy for some macroeconomic variables, such as industrial production, employment, and Fed fund rate. Copyright © 2011 John Wiley & Sons, Ltd.