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What causes the forecasting failure of Markov-Switching models? A Monte Carlo study

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Author Info
Marie Bessec (EURIsCO - University Paris Dauphine)
Othman Bouabdallah (EUREQua - University Paris Panthéon Sorbonne)

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Abstract

This paper explores the forecasting abilities of Markov-Switching models. Although MS models generally display a superior in-sample fit relative to linear models, the gain in prediction remains small. We confirm this result using simulated data for a wide range of specifications by applying several tests of forecast accuracy and encompassing robust to nested models. In order to explain this poor performance, we use a forecasting error decomposition. We identify four components and derive their analytical expressions in different MS specifications. The relative contribution of each source is assessed through Monte Carlo simulations. We find that the main source of error is due to the misclassification of future regimes.

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Paper provided by EconWPA in its series Econometrics with number 0503018.

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Length: 19 pages
Date of creation: 22 Mar 2005
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Handle: RePEc:wpa:wuwpem:0503018

Note: Type of Document - pdf; pages: 19
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Related research
Keywords: Forecasting Regime Shifts Markov-Switching.

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Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  4. Clements, Michael P. & Franses, Philip Hans & Swanson, Norman R., 2004. "Forecasting economic and financial time-series with non-linear models," International Journal of Forecasting, Elsevier, vol. 20(2), pages 169-183. [Downloadable!] (restricted)
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  5. Clements, Michael P & Krolzig, Hans-Martin, 2003. "Business Cycle Asymmetries: Characterization and Testing Based on Markov-Switching Autoregressions," Journal of Business & Economic Statistics, American Statistical Association, vol. 21(1), pages 196-211, January.
  6. Bidarkota, Prasad V, 2001. "Alternative Regime Switching Models for Forecasting Inflation," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 20(1), pages 21-35, January.
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  9. Michael P. Clements & Hans-Martin Krolzig, 1998. "A comparison of the forecast performance of Markov-switching and threshold autoregressive models of US GNP," Econometrics Journal, Royal Economic Society, vol. 1(Conferenc), pages C47-C75.
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  13. Garcia, Rene & Perron, Pierre, 1996. "An Analysis of the Real Interest Rate under Regime Shifts," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 111-25, February. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Adam Misiorek & Stefan Trueck & Rafal Weron, 2006. "Point and Interval Forecasting of Spot Electricity Prices: Linear vs. Non-Linear Time Series Models," Studies in Nonlinear Dynamics & Econometrics, Berkeley Electronic Press, vol. 10(3), pages 1362-1362. [Downloadable!] (restricted)
  2. Brent Bundick, 2007. "Do federal funds futures need adjustment for excess returns? a state-dependent approach," Research Working Paper RWP 07-08, Federal Reserve Bank of Kansas City. [Downloadable!]
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