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Optimal Forecast Combination Under Regime Switching

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  • Graham Elliott
  • Allan Timmermann

Abstract

This article proposes a new forecast combination method that lets the combination weights be driven by regime switching in a latent state variable. An empirical application that combines forecasts from survey data and time series models finds that the proposed regime switching combination scheme performs well for a variety of macroeconomic variables. Monte Carlo simulations shed light on the type of data-generating processes for which the proposed combination method can be expected to perform better than a range of alternative combination schemes. Finally, we show how time variations in the combination weights arise when the target variable and the predictors share a common factor structure driven by a hidden Markov process. Copyright 2005 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.

Suggested Citation

  • Graham Elliott & Allan Timmermann, 2005. "Optimal Forecast Combination Under Regime Switching ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(4), pages 1081-1102, November.
    • Handle: RePEc:ier:iecrev:v:46:y:2005:i:4:p:1081-1102
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    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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