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What Causes The Forecasting Failure of Markov-Switching Models? A Monte Carlo Study

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Listed author(s):
  • Bessec Marie

    ()

    (EURIsCO, University of Paris Dauphine)

  • Bouabdallah Othman

    ()

    (EUREQua, University of Paris 1 Panthéon Sorbonne)

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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Article provided by De Gruyter in its journal Studies in Nonlinear Dynamics & Econometrics.

Volume (Year): 9 (2005)
Issue (Month): 2 (June)
Pages: 1-24

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Handle: RePEc:bpj:sndecm:v:9:y:2005:i:2:n:6
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Find related papers by JEL classification:
  • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
  • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
  • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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  1. 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.
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  7. Engel, Charles & Hamilton, James D, 1990. "Long Swings in the Dollar: Are They in the Data and Do Markets Know It?," American Economic Review, American Economic Association, vol. 80(4), pages 689-713, September.
  8. Todd E. Clark & Michael W. McCracken, 2001. "Evaluating long-horizon forecasts," Research Working Paper RWP 01-14, Federal Reserve Bank of Kansas City.
  9. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1990. "Mean Reversion in Equilibrium Asset Prices," American Economic Review, American Economic Association, vol. 80(3), pages 398-418, June.
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Cited by:

  1. Katarzyna Maciejowska & Rafal Weron, 2015. "Short- and mid-term forecasting of baseload electricity prices in the UK: The impact of intra-day price relationships and market fundamentals," HSC Research Reports HSC/15/04, Hugo Steinhaus Center, Wroclaw University of Technology.
  2. Mahua Barari & Nityananda Sarkar & Srikanta Kundu & Kushal Banik Chowdhury, 2014. "Forecasting House Prices in the United States with Multiple Structural Breaks," International Econometric Review (IER), Econometric Research Association, vol. 6(1), pages 1-23, April.
  3. W. Miles, 2008. "Boom–Bust Cycles and the Forecasting Performance of Linear and Non-Linear Models of House Prices," The Journal of Real Estate Finance and Economics, Springer, vol. 36(3), pages 249-264, April.
  4. Rafal Weron, 2006. "Modeling and Forecasting Electricity Loads and Prices: A Statistical Approach," HSC Books, Hugo Steinhaus Center, Wroclaw University of Technology, number hsbook0601, December.
  5. Weron, Rafal & Misiorek, Adam, 2008. "Forecasting spot electricity prices: A comparison of parametric and semiparametric time series models," International Journal of Forecasting, Elsevier, vol. 24(4), pages 744-763.
  6. Joanna Janczura & Rafał Weron, 2013. "Goodness-of-fit testing for the marginal distribution of regime-switching models with an application to electricity spot prices," AStA Advances in Statistical Analysis, Springer;German Statistical Society, vol. 97(3), pages 239-270, July.
  7. Misiorek Adam & Trueck Stefan & Weron Rafal, 2006. "Point and Interval Forecasting of Spot Electricity Prices: Linear vs. Non-Linear Time Series Models," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 10(3), pages 1-36, September.
  8. Serinaldi, Francesco, 2011. "Distributional modeling and short-term forecasting of electricity prices by Generalized Additive Models for Location, Scale and Shape," Energy Economics, Elsevier, vol. 33(6), pages 1216-1226.
  9. Adam Misiorek & Rafal Weron, 2006. "Interval forecasting of spot electricity prices," HSC Research Reports HSC/06/05, Hugo Steinhaus Center, Wroclaw University of Technology.
  10. Weron, Rafał, 2014. "Electricity price forecasting: A review of the state-of-the-art with a look into the future," International Journal of Forecasting, Elsevier, vol. 30(4), pages 1030-1081.
  11. 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.
  12. Giordani, Paolo & Villani, Mattias, 2010. "Forecasting macroeconomic time series with locally adaptive signal extraction," International Journal of Forecasting, Elsevier, vol. 26(2), pages 312-325, April.
  13. Arora Siddharth & Little Max A. & McSharry Patrick E., 2013. "Nonlinear and nonparametric modeling approaches for probabilistic forecasting of the US gross national product," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 17(4), pages 395-420, September.

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