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Nested forecast model comparisons: a new approach to testing equal accuracy

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  • Todd E. Clark
  • Michael W. McCracken

Abstract

This paper develops bootstrap methods for testing whether, in a finite sample, competing out-of-sample forecasts from nested models are equally accurate. Most prior work on forecast tests for nested models has focused on a null hypothesis of equal accuracy in population basically, whether coefficients on the extra variables in the larger, nesting model are zero. We instead use an asymptotic approximation that treats the coefficients as non-zero but small, such that, in a finite sample, forecasts from the small model are expected to be as accurate as forecasts from the large model. Under that approximation, we derive the limiting distributions of pairwise tests of equal mean square error, and develop bootstrap methods for estimating critical values. Monte Carlo experiments show that our proposed procedures have good size and power properties for the null of equal finite-sample forecast accuracy. We illustrate the use of the procedures with applications to forecasting stock returns and inflation.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 09-11.

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Date of creation: 2009
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Handle: RePEc:fip:fedkrw:rwp09-11

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Cited by:
  1. Andrea CARRIERO & Todd E. CLARK & Massimiliano MARCELLINO, 2012. "Common Drifting Volatility in Large Bayesian VARs," Economics Working Papers ECO2012/08, European University Institute.
  2. Calhoun, Gray, 2014. "Out-Of-Sample Comparisons of Overfit Models," Staff General Research Papers 32462, Iowa State University, Department of Economics.
  3. Alquist, Ron & Kilian, Lutz & Vigfusson, Robert J., 2011. "Forecasting the Price of Oil," CEPR Discussion Papers 8388, C.E.P.R. Discussion Papers.
  4. Francesco Ravazzolo & Philip Rothman, 2011. "Oil and US GDP: A Real-Time out-of Sample Examination," Working Papers 0004, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
  5. Guérin, Pierre & Maurin, Laurent & Mohr, Matthias, 2011. "Trend-cycle decomposition of output and euro area inflation forecasts: a real-time approach based on model combination," Working Paper Series 1384, European Central Bank.
  6. Arai, Natsuki, 2014. "Using forecast evaluation to improve the accuracy of the Greenbook forecast," International Journal of Forecasting, Elsevier, vol. 30(1), pages 12-19.
  7. Lutz Kilian & Robert J. Vigfusson, 2012. "Do oil prices help forecast U.S. real GDP? the role of nonlinearities and asymmetries," International Finance Discussion Papers 1050, Board of Governors of the Federal Reserve System (U.S.).
  8. Todd E.Clark & Taeyoung Doh, 2011. "A Bayesian evaluation of alternative models of trend inflation," Research Working Paper RWP 11-16, Federal Reserve Bank of Kansas City.
  9. Todd E. Clark & Michael W. McCracken, 2011. "Advances in forecast evaluation," Working Papers 2011-025, Federal Reserve Bank of St. Louis.
  10. Todd E. Clark & Michael W. McCracken, 2010. "Reality checks and nested forecast model comparisons," Working Papers 2010-032, Federal Reserve Bank of St. Louis.
  11. Todd E. Clark & Michael W. McCracken, 2010. "Testing for unconditional predictive ability," Working Papers 2010-031, Federal Reserve Bank of St. Louis.
  12. Nikolsko-Rzhevskyy, Alex & Prodan, Ruxandra, 2012. "Markov switching and exchange rate predictability," International Journal of Forecasting, Elsevier, vol. 28(2), pages 353-365.

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