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Penalized Splines with an Application in Economics

Nonparametric smoothing has become the norm of statistics research in the last few decades. The advantage of nonparametric smoothing is its data driven nature. It does not assume any predetermined functional form but allow data to speak for themselves. One particularly popular nonparametric smoothing technique is penalized splines or P-splines. This technique is popular partly because it is computationally expedient and flexible enough to be adapted in complex models. Despite of its popularity in statistics methodological research, its applications in other areas such as finance and economics are limited. One reason for such limited applications is that P-splines remain unknown to most economics researchers. This chapter introduces the general idea of penalized splines and illustrates its application in forecasting US real GNP. Some references and resources are pointed out for future researches.