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Forecasting Under Strucural Break Uncertainty

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  • Jing Tian
  • Heather M. Anderson

    ()

Abstract

This paper proposes two new weighting schemes that average forecasts using different estimation windows to account for structural change. We let the weights reflect the probability of each time point being the most-recent break point, and we use the reversed ordered Cusum test statistics to capture this intuition. The second weighting method simply imposes heavier weights on those forecasts that use more recent information. The proposed combination forecasts are evaluated using Monte Carlo techniques, and we compare them with forecasts based on other methods that try to account for structural change, including average forecasts weighted by past forecasting performance and techniques that first estimate a break point and then forecast using the post break data. Simulation results show that our proposed weighting methods often outperform the others in the presence of structural breaks. An empirical application based on a NAIRU Phillips curve model for the United States indicates that it is possible to outperform the random walk forecasting model when we employ forecasting methods that account for break uncertainty.

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File URL: http://www.buseco.monash.edu.au/ebs/pubs/wpapers/2011/wp8-11.pdf
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Bibliographic Info

Paper provided by Monash University, Department of Econometrics and Business Statistics in its series Monash Econometrics and Business Statistics Working Papers with number 8/11.

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Length: 36 pages
Date of creation: Jul 2011
Date of revision:
Handle: RePEc:msh:ebswps:2011-8

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Related research

Keywords: Forecasting with Structural breaks; Parameter Shifts; break Uncertainty; Structural break Tests; Choice of Estimation Sample; Forecast Combinations; NAIRU Phillips Curve.;

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  1. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  2. 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.
  3. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  4. Pesaran, M. Hashem & Timmermann, Allan, 2002. "Market timing and return prediction under model instability," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 495-510, December.
  5. Stock, James H. & Watson, Mark W., 1999. "Forecasting inflation," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 293-335, October.
  6. Clark, Todd E. & McCracken, Michael W., 2005. "The power of tests of predictive ability in the presence of structural breaks," Journal of Econometrics, Elsevier, vol. 124(1), pages 1-31, January.
  7. Robert J. Gordon, 1997. "The Time-Varying NAIRU and its Implications for Economic Policy," NBER Working Papers 5735, National Bureau of Economic Research, Inc.
  8. Jonas D. M. Fisher & Chin Te Liu & Ruilin Zhou, 2002. "When can we forecast inflation?," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 32-44.
  9. Tobin, James, 1972. "Inflation and Unemployment," American Economic Review, American Economic Association, vol. 62(1), pages 1-18, March.
  10. Douglas Staiger & James H. Stock & Mark W. Watson, 1997. "The NAIRU, Unemployment and Monetary Policy," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 33-49, Winter.
  11. Jushan Bai & Pierre Perron, 2003. "Computation and analysis of multiple structural change models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 18(1), pages 1-22.
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