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Robustifying Forecasts from Equilibrium-Correction Models

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  • David F. Hendry

    ()
    (Economcis Department, University of Oxford)

Abstract

In a non-stationary world subject to structural breaks, where model and mechanism differ, equilibrium-correction models are a risky device from which to forecast. Equilibrium shifts entail systematic forecast failure, and indeed forecasts will tend to move in the opposite direction to the data. A new explanation for the empirical success of second differencing is proposed. We consider model transformations based on additional differencing to reduce forecast-error biases, as usual at some cost in increased forecast-error variances. The analysis is illustrated by an empirical application to narrow money holdings in the UK.

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File URL: http://www.nuff.ox.ac.uk/economics/papers/2004/w14/DFHEqCMRobust.pdf
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Bibliographic Info

Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2004-W14.

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Length: 30 pages
Date of creation: 01 Apr 2004
Date of revision:
Handle: RePEc:nuf:econwp:0414

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Web page: http://www.nuff.ox.ac.uk/economics/

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  10. Melino, Angelo & Turnbull, Stuart M., 1990. "Pricing foreign currency options with stochastic volatility," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 239-265.
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  12. Michael P. Clements & David F. Hendry, 2001. "Forecasting Non-Stationary Economic Time Series," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262531895, December.
  13. Makridakis, Spyros & Hibon, Michele, 2000. "The M3-Competition: results, conclusions and implications," International Journal of Forecasting, Elsevier, vol. 16(4), pages 451-476.
  14. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164.
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