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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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number
408.
Find related papers by JEL classification: C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications
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