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Forecasting with Equilibrium-correction Models during Structural Breaks

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  • Jennifer Castle
  • David Hendry
  • Nicholas W.P. Fawcett

Abstract

When breaks occur, equilibrium-correction models (EqCMs) based on cointegration face forecasting problems.� We investigate approaches to alleviate forecast failure following a location shift, including updating, intercept corrections, differencing, and estimating the future impact of an 'internal' break during its progress.� Although updating can lead to a loss of cointegration when an EqCM suffers an equilibrium-mean shift, we show that updating can help when collinearities are changed by an 'external' break and the EqCM itself remains constant.� Both mechanistic corrections help compared to just retaining a pre-break estimated model, but an estimated model of the break process could outperform.� Throughout, we apply the approaches to the much-studied example of EqCMs for UK M1, and compare with updating a learning function as the break evolves.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 408.

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Date of creation: 01 Oct 2008
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Handle: RePEc:oxf:wpaper:408

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Keywords: Forecasting; Location Shifts; Equilibrium-Correction Models;

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References

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  1. David Hendry & Carlos Santos, 2003. "Regression Models with Data-based Indicator Variables," Economics Series Working Papers 2004-W04, University of Oxford, Department of Economics.
  2. Michael P. Clements & David F. Hendry, 2005. "Guest Editors' Introduction: Information in Economic Forecasting," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(s1), pages 713-753, December.
  3. Perron, P, 1988. "The Great Crash, The Oil Price Shock And The Unit Root Hypothesis," Papers, Princeton, Department of Economics - Econometric Research Program 338, Princeton, Department of Economics - Econometric Research Program.
  4. Pesaran, M. Hashem & Pettenuzzo, Davide & Timmermann, Allan, 2004. "Forecasting Time Series Subject to Multiple Structural Breaks," IZA Discussion Papers 1196, Institute for the Study of Labor (IZA).
  5. Hendry, David F. & Ericsson, Neil R., 1991. "Modeling the demand for narrow money in the United Kingdom and the United States," European Economic Review, Elsevier, Elsevier, vol. 35(4), pages 833-881, May.
  6. Clements,Michael & Hendry,David, 1998. "Forecasting Economic Time Series," Cambridge Books, Cambridge University Press, Cambridge University Press, number 9780521632423.
  7. Katarina Juselius & David F. Hendry, 2000. "Explaining Cointegration Analysis: Part II," Discussion Papers 00-20, University of Copenhagen. Department of Economics.
  8. Jurgen Doornik & H. Peter Boswijk, 2003. "Identifying, Estimating and Testing Restricted Cointegrated Systems: An Overview," Economics Series Working Papers 2003-W10, University of Oxford, Department of Economics.
  9. Hendry, David F., 2000. "On detectable and non-detectable structural change," Structural Change and Economic Dynamics, Elsevier, Elsevier, vol. 11(1-2), pages 45-65, July.
  10. Granger, C. W. J., 1981. "Some properties of time series data and their use in econometric model specification," Journal of Econometrics, Elsevier, Elsevier, vol. 16(1), pages 121-130, May.
  11. Hendry, David F & Doornik, Jurgen A, 1994. "Modelling Linear Dynamic Econometric Systems," Scottish Journal of Political Economy, Scottish Economic Society, vol. 41(1), pages 1-33, February.
  12. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, Econometric Society, vol. 55(2), pages 251-76, March.
  13. Hendry, David F., 2006. "Robustifying forecasts from equilibrium-correction systems," Journal of Econometrics, Elsevier, Elsevier, vol. 135(1-2), pages 399-426.
  14. Michael P. Clements & David F. Hendry, 2001. "Forecasting Non-Stationary Economic Time Series," MIT Press Books, The MIT Press, The MIT Press, edition 1, volume 1, number 0262531895, December.
  15. Davidson, James E H, et al, 1978. "Econometric Modelling of the Aggregate Time-Series Relationship between Consumers' Expenditure and Income in the United Kingdom," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 88(352), pages 661-92, December.
  16. Clements, Michael P. & Hendry, David F., 2006. "Forecasting with Breaks," Handbook of Economic Forecasting, Elsevier, Elsevier.
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As found on the RePEc Biblio, the curated bibliography for Economics:
  1. > Econometrics > Forecasting
  2. > Econometrics > Forecasting
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Cited by:
  1. David Hendry & Grayham E. Mizon, 2013. "Unpredictability in Economic Analysis, Econometric Modeling and Forecasting," Economics Series Working Papers 2013-W04, University of Oxford, Department of Economics.
  2. David F. Hendry, 2011. "Empirical Economic Model Discovery and Theory Evaluation," Rationality, Markets and Morals, Frankfurt School Verlag, Frankfurt School of Finance & Management, Frankfurt School Verlag, Frankfurt School of Finance & Management, vol. 2(46), October.
  3. Michael Wickens, 2014. "How Useful are DSGE Macroeconomic Models for Forecasting?," Open Economies Review, Springer, Springer, vol. 25(1), pages 171-193, February.
  4. David Hendry & Grayham E. Mizon, 2012. "Forecasting from Structural Econometric Models," Economics Series Working Papers 597, University of Oxford, Department of Economics.
  5. Jennifer Castle & David Hendry, 2013. "Forecasting and Nowcasting Macroeconomic Variables: A Methodological Overview," Economics Series Working Papers 674, University of Oxford, Department of Economics.
  6. David Hendry & Soren Johansen, 2012. "Model Discovery and Trygve Haavelmo's Legacy," Economics Series Working Papers 598, University of Oxford, Department of Economics.
  7. Jennifer Castle & David Hendry & Michael P. Clements, 2014. "Robust Approaches to Forecasting," Economics Series Working Papers 697, University of Oxford, Department of Economics.
  8. David Hendry & Carlos Santos, 2010. "An Automatic Test of Super Exogeneity," Economics Series Working Papers 476, University of Oxford, Department of Economics.
  9. David Hendry & Michael P. Clements, 2010. "Forecasting from Mis-specified Models in the Presence of Unanticipated Location Shifts," Economics Series Working Papers 484, University of Oxford, Department of Economics.
  10. Allanson, Paul & Petrie, Dennis, 2013. "Longitudinal methods to investigate the role of health determinants in the dynamics of income-related health inequality," Journal of Health Economics, Elsevier, Elsevier, vol. 32(5), pages 922-937.

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