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Detecting and predicting forecast breakdowns

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Author Info
Raffaella Giacomini () (Department of Economics, UCLA, Box 951477, Los Angeles, CA 90095-1477, USA.)
Barbara Rossi () (Department of Economics, Duke University, Durham NC27708, USA.)

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Abstract

We propose a theoretical framework for assessing whether a forecast model estimated over one period can provide good forecasts over a subsequent period. We formalize this idea by defining a forecast breakdown as a situation in which the out-of-sample performance of the model, judged by some loss function, is significantly worse than its in-sample performance. Our framework, which is valid under general conditions, can be used not only to detect past forecast breakdowns but also to predict future ones. We show that main causes of forecast breakdowns are instabilities in the data generating process and relate the properties of our forecast breakdown test to those of existing structural break tests. The empirical application finds evidence of a forecast breakdown in the Phillips’ curve forecasts of U.S. inflation, and links it to inflation volatility and to changes in the monetary policy reaction function of the Fed. JEL Classification: C22; C52; C53.

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Paper provided by European Central Bank in its series Working Paper Series with number 638.

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Length: 49 pages
Date of creation: Jun 2006
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Handle: RePEc:ecb:ecbwps:20060638

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Related research
Keywords: Structural change forecast evaluation forecast rationality testing in-sample evaluation out-of-sample evaluation.

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  3. Rossi, Barbara, 2005. "Optimal Tests For Nested Model Selection With Underlying Parameter Instability," Econometric Theory, Cambridge University Press, vol. 21(05), pages 962-990, August. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Doyle, Matthew, 2006. "Empirical Phillips Curves in OECD Countries: Has There Been A Common Breakdown?," Staff General Research Papers 12684, Iowa State University, Department of Economics. [Downloadable!]
  2. Kai Carstensen, 2007. "Is core money growth a good and stable inflation predictor in the euro area?," Kiel Working Papers 1318, Kiel Institute for the World Economy. [Downloadable!]
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