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Forecasting Random Walks Under Drift Instability

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  • Pesaran, M.H.
  • Pick, A.

Abstract

This paper considers forecast averaging when the same model is used but estimation is carried out over different estimation windows. It develops theoretical results for random walks when their drift and/or volatility are subject to one or more structural breaks. It is shown that compared to using forecasts based on a single estimation window, averaging over estimation windows leads to a lower bias and to a lower root mean square forecast error for all but the smallest of breaks. Similar results are also obtained when observations are exponentially down-weighted, although in this case the performance of forecasts based on exponential down-weighting critically depends on the choice of the weighting coefficient. The forecasting techniques are applied to monthly inflation series of 21 OECD countries and it is found that average forecasting methods in general perform better than using forecasts based on a single estimation window.

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File URL: http://www.econ.cam.ac.uk/research/repec/cam/pdf/cwpe0814.pdf
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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0814.

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Length: 24
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:cam:camdae:0814

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Web page: http://www.econ.cam.ac.uk/index.htm

Related research

Keywords: Forecast combinations; averaging over estimation windows; exponentially down-weighting observations; structural breaks.;

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References

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  1. Todd E. Clark & Michael W. McCracken, 2004. "Improving forecast accuracy by combining recursive and rolling forecasts," Research Working Paper RWP 04-10, Federal Reserve Bank of Kansas City.
  2. Wiliam Branch & George W. Evans, 2005. "A Simple Recursive Forecasting Model," University of Oregon Economics Department Working Papers 2005-3, University of Oregon Economics Department, revised 01 Feb 2005.
  3. Marco Aiolfi & Carlos Capistrán & Allan Timmermann, 2010. "Forecast Combinations," CREATES Research Papers 2010-21, School of Economics and Management, University of Aarhus.
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  7. M. Hashem Pesaran & Til Schuermann & L. Vanessa Smith, 2008. "Forecasting economic and financial variables with global VARs," Staff Reports 317, Federal Reserve Bank of New York.
  8. Todd E. Clark & Michael W. McCracken, 2008. "Averaging forecasts from VARs with uncertain instabilities," Working Papers 2008-030, Federal Reserve Bank of St. Louis.
  9. Katrin Assenmacher-Wesche & M. Hashem Pesaran, 2008. "Forecasting the Swiss Economy Using Vecx* Models: an Exercise in Forecast Combination Across Models and Observation Windows," National Institute Economic Review, National Institute of Economic and Social Research, vol. 203(1), pages 91-108, January.
  10. Burdekin, R.C.K. & Siklos, P.L., 1997. "Exchange Rate Regimes and Shfts in Inflation Persistence: Does Nothing Else Matter?," Working Papers 97-2, Wilfrid Laurier University, Department of Economics.
  11. Pesaran, M. Hashem & Timmermann, Allan, 2007. "Selection of estimation window in the presence of breaks," Journal of Econometrics, Elsevier, vol. 137(1), pages 134-161, March.
  12. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  13. Harvey,Andrew C., 1990. "Forecasting, Structural Time Series Models and the Kalman Filter," Cambridge Books, Cambridge University Press, number 9780521321969, November.
  14. Carlos Robalo Marques, 2004. "Inflation Persistence: Facts or Artefacts?," Working Papers w200408, Banco de Portugal, Economics and Research Department.
  15. BAI, Jushan & PERRON, Pierre, 1998. "Computation and Analysis of Multiple Structural-Change Models," Cahiers de recherche 9807, Universite de Montreal, Departement de sciences economiques.
  16. Clements, Michael P. & Hendry, David F., 2006. "Forecasting with Breaks," Handbook of Economic Forecasting, Elsevier.
  17. Clemen, Robert T., 1989. "Combining forecasts: A review and annotated bibliography," International Journal of Forecasting, Elsevier, vol. 5(4), pages 559-583.
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Cited by:
  1. Pesaran, M.H. & Schuermann, T. & Smit, L.V., 2008. "Forecasting Economic and Financial Variables with Global VARs," Cambridge Working Papers in Economics 0807, Faculty of Economics, University of Cambridge.
  2. Eklund, Jana & Kapetanios, George & Price, Simon, 2010. "Forecasting in the presence of recent structural change," Bank of England working papers 406, Bank of England.

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