Dynamic principal component regression: Application to age-specific mortality forecasting

Abstract: In areas of application, including actuarial science and demography, it is increasingly common to consider a time series of curves; an example of this is age-specific mortality rates observed over a period of years. Given that age can be treated as a discrete or continuous variable, a dimension reduction technique, such as principal component analysis, is often implemented. However, in the presence of moderate to strong temporal dependence, static principal component analysis commonly used for analyzing independent and identically distributed data may not be adequate. As an alternative, we consider a \textit{dynamic} principal component approach to model temporal dependence in a time series of curves. Inspired by Brillinger's (1974) theory of dynamic principal components, we introduce a dynamic principal component analysis, which is based on eigen-decomposition of estimated long-run covariance. Through a series of empirical applications, we demonstrate the potential improvement of one-year-ahead point and interval forecast accuracies that the dynamic principal component regression entails when compared with the static counterpart.