Cluster-Based Regularized Sliced Inverse Regression for Forecasting Macroeconomic Variables

Abstract: This article concerns the dimension reduction in regression for large data set. We introduce a new method based on the sliced inverse regression approach, called cluster-based regularized sliced inverse regression. Our 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 our method has outperformed the dynamic factor model and other shrinkage methods.