Testable Implications of Forecast Optimality

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Testable Implications of Forecast Optimality

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Andrew J. Patton
Allan Timmermann

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Abstract

Evaluation of forecast optimality in economics and finance has almost exclusively been conducted on the assumption of mean squared error loss under which forecasts should be unbiased and forecast errors serially uncorrelated at the single period horizon with increasing variance as the forecast horizon grows. This paper considers properties of optimal forecasts under general loss functions and establishes new testable implications of forecast optimality. These hold when the forecaster's loss function is unknown but testable restrictions can be imposed on the data generating process, trading off conditions on the data generating process against conditions on the loss function. Finally, we propose flexible parametric estimation of the forecaster's loss function, and obtain a test of forecast optimality via a test of over-identifying restrictions.

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Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Econometrics Paper Series with number /2005/485.

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Date of creation: Jan 2005
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Handle: RePEc:cep:stiecm:/2005/485

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Find related papers by JEL classification:
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing

This paper has been announced in the following NEP Reports:

NEP-ALL-2006-02-26 (All new papers)
NEP-ECM-2006-02-26 (Econometrics)
NEP-ETS-2006-02-26 (Econometric Time Series)
NEP-FOR-2006-02-26 (Forecasting)

References listed on IDEAS
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Rossi, Barbara & Giacomini, Raffaella, 2006. "Detecting and Predicting Forecast Breakdowns," Working Papers 06-01, Duke University, Department of Economics. [Downloadable!]
Other versions:
- Raffella Giacomini & Barbara Rossi, 2005. "Detecting and Predicting Forecast Breakdowns," UCLA Economics Working Papers 845, UCLA Department of Economics. [Downloadable!]
- Raffaella Giacomini & Barbara Rossi, 2006. "Detecting and predicting forecast breakdowns," Working Paper Series 638, European Central Bank. [Downloadable!]
- Raffaella Giacomini & Barbara Rossi, 2009. "Detecting and Predicting Forecast Breakdowns," Review of Economic Studies, Blackwell Publishing, vol. 76(2), pages 669-705, 03. [Downloadable!] (restricted)

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