Extracting Nonlinear Signals from Several Economic Indicators. (19th September 2014)

• Record Type: Journal Article
• Authors: Camacho, Maximo; Perez‐Quiros, Gabriel; Poncela, Pilar
• Is Part Of: Journal of applied econometrics. Volume 30:Number 7(2015)
• Page Start: 1073
• Page End: 1089
• Publication Date: 2014-09-19
• Subjects: Econometrics -- Periodicals; 330.015195
• DOI: 10.1002/jae.2416
• Languages: English
• ISSNs: 0883-7252

Abstract

Summary: We develop a twofold analysis of how the information provided by several economic indicators can be used in Markov switching dynamic factor models to identify the business cycle turning points. First, we compare the performance of a fully nonlinear multivariate specification (one‐step approach) with the 'shortcut' of using a linear factor model to obtain a coincident indicator, which is then used to compute the Markov switching probabilities (two‐step approach). Second, we examine the role of increasing the number of indicators. Our results suggest that one step is generally preferred to two steps, especially in the vicinity of turning points, although its gains diminish as the quality of the indicators increases. Additionally, we also obtain decreasing returns of adding more indicators with similar signal‐to‐noise ratios. Using the four constituent series of the Stock–Watson coincident index, we illustrate these results for US data. Copyright © 2014 John Wiley & Sons, Ltd.