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The Role of the Log Transformation in Forecasting Economic Variables

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  • Helmut Luetkepohl
  • Fang Xu

Abstract

For forecasting and economic analysis many variables are used in logarithms (logs). In time series analysis this transformation is often considered to stabilize the variance of a series. We investigate under which conditions taking logs is beneficial for forecasting. Forecasts based on the original series are compared to forecasts based on logs. It is found that it depends on the data generation process whether the former or the latter are preferable. For a range of economic variables substantial forecasting improvements from taking logs are found if the log transformation actually stabilizes the variance of the underlying series. Using logs can be damaging for the forecast precision if a stable variance is not achieved.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2591.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2591

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Keywords: autoregressive moving average process; forecast mean squared error; instantaneous transformation; integrated process; heteroskedasticity;

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References

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  1. Ari�o, M.A. & Franses, Ph.H.B.F., 1996. "Forecasting the Levels of Vector Autoregressive Log-Transformed Time Series," Econometric Institute Research Papers EI 9669-/A, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  2. Christopher A. Sims & Tao Zha, 2004. "Were there regime switches in U.S. monetary policy?," Working Paper, Federal Reserve Bank of Atlanta 2004-14, Federal Reserve Bank of Atlanta.
  3. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 20(1), pages 134-44, January.
  4. Corradi, Valentina & Swanson, Norman R., 2006. "The effect of data transformation on common cycle, cointegration, and unit root tests: Monte Carlo results and a simple test," Journal of Econometrics, Elsevier, Elsevier, vol. 132(1), pages 195-229, May.
  5. Markku Lanne & Helmut Luetkepohl, 2006. "Identifying Monetary Policy Shocks viaChanges in Volatility," CESifo Working Paper Series 1744, CESifo Group Munich.
  6. Krämer, Walter & Davies, Laurie, 2000. "Testing for unit roots in the context of misspecified logarithmic random walks," Technical Reports 2000,30, Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen.
  7. Harvey, David & Leybourne, Stephen & Newbold, Paul, 1997. "Testing the equality of prediction mean squared errors," International Journal of Forecasting, Elsevier, Elsevier, vol. 13(2), pages 281-291, June.
  8. SILVESTRINI, Andrea & SALTo, Matteo & MOULIN, Laurent & VEREDAS, David, . "Monitoring and forecasting annual public deficit every month: the case of France," CORE Discussion Papers RP, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) -2019, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  9. Christopher A. Sims & Daniel F. Waggoner & Tao Zha, 2006. "Methods for inference in large multiple-equation Markov-switching models," Working Paper, Federal Reserve Bank of Atlanta 2006-22, Federal Reserve Bank of Atlanta.
  10. Granger, C. W. J. & Newbold, P., 1976. "The use of R2 to determine the appropriate transformation of regression variables," Journal of Econometrics, Elsevier, Elsevier, vol. 4(3), pages 205-210, August.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Log Transformations & Forecasting
    by Dave Giles in Econometrics Beat: Dave Giles' Blog on 2012-05-22 19:20:00
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Cited by:
  1. Grosche, Stephanie & Heckelei, Thomas, 2014. "Directional Volatility Spillovers between Agricultural, Crude Oil, Real Estate and other Financial Markets," Discussion Papers, University of Bonn, Institute for Food and Resource Economics 166079, University of Bonn, Institute for Food and Resource Economics.
  2. Roxana Halbleib & Valerie Voev, 2011. "Forecasting Covariance Matrices: A Mixed Frequency Approach," Working Papers ECARES, ULB -- Universite Libre de Bruxelles ECARES 2010-002, ULB -- Universite Libre de Bruxelles.
  3. Ji, In Bae & Chung, Chanjin, 2012. "Causality Between Captive Supplies and Cash Market Prices in the U.S. Cattle Procurement Market," Agricultural and Resource Economics Review, Northeastern Agricultural and Resource Economics Association, Northeastern Agricultural and Resource Economics Association, vol. 41(3), December.
  4. Lütkepohl, Helmut & Proietti, Tommaso, 2011. "Does the Box-Cox transformation help in forecasting macroeconomic time series?," Working Papers 1 OMEWP, University of Sydney Business School, Discipline of Business Analytics.
  5. Bårdsen, Gunnar & Lütkepohl, Helmut, 2011. "Forecasting levels of log variables in vector autoregressions," International Journal of Forecasting, Elsevier, Elsevier, vol. 27(4), pages 1108-1115, October.
  6. Kriechbaumer, Thomas & Angus, Andrew & Parsons, David & Rivas Casado, Monica, 2014. "An improved wavelet–ARIMA approach for forecasting metal prices," Resources Policy, Elsevier, Elsevier, vol. 39(C), pages 32-41.
  7. Rossen, Anja, 2011. "On the predictive content of nonlinear transformations of lagged autoregression residuals and time series observations," HWWI Research Papers 113, Hamburg Institute of International Economics (HWWI).
  8. Festic, Mejra & Kavkler, Alenka & Repina, Sebastijan, 2011. "The macroeconomic sources of systemic risk in the banking sectors of five new EU member states," Journal of Banking & Finance, Elsevier, Elsevier, vol. 35(2), pages 310-322, February.
  9. Helmut Luetkepohl, 2009. "Forecasting Aggregated Time Series Variables: A Survey," Economics Working Papers, European University Institute ECO2009/17, European University Institute.

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