TY  - JOUR
AU  - Stock,James H.
AU  - Watson,Mark W.
TI  - Diffusion Indexes
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 6702
PY  - 1998
Y2  - August 1998
UR  - http://www.nber.org/papers/w6702
L1  - http://www.nber.org/papers/w6702.pdf
N1  - Author contact info:
James H. Stock
Department of Economics
Harvard University
Littauer Center M27
Cambridge, MA 02138
Tel: 617/496-0502
Fax: 617/495-7730
E-Mail: James_Stock@harvard.edu

Mark W. Watson
Department of Economics
Princeton University
Princeton, NJ 08544-1013
Tel: 609/258-4811
Fax: 609/258-5533
E-Mail: mwatson@princeton.edu
AB  - This paper considers forecasting a single time series using more predictors than there are time series observations.  The approach is to construct a relatively few indexes, akin to diffusion indexes, which are weighted averages of the predictors, using an approximate dynamic factor model.  Estimation is discussed for balanced and unbalanced panels.  The estimated dynamic factors are (uniformly) consistent, even in the presence of time varying parameters and/or data contamination, and forecasts based on the estimated factors are efficient.  In an application to forecasting U.S. inflation and industrial production using 224 monthly time series, these forecasts outperform various state-of-the-art benchmark models.
ER  -