Cluster-based regularized sliced inverse regression for forecasting macroeconomic variables

Abstract

This paper concerns the dimension reduction in regression for large data set. The authors introduce a new method based on the sliced inverse regression approach, called cluster-based regularized sliced inverse regression. The proposed method not only keeps the merit of considering both response and predictors’ information, but also enhances the capability of handling highly correlated variables. It is justified under certain linearity conditions. An empirical application on a macroeconomic data set shows that the proposed method has outperformed the dynamic factor model and other shrinkage methods.