Forecasting with Leading Indicators by means of the Principal Covariate Index

Abstract

. We thank two anonymous referees for useful comments and suggestions and Tatyana Bulavskaya for excellent computational assistance. A new method of leading index construction is proposed, which explicitly takes into account the purpose of using the index for forecasting a coincident economic indicator. This so-called principal covariate index combines the need for compressing the information in a large number of individual leading indicator variables with the objective of forecasting. In an empirical application to forecast