Optimal Prediction Under Asymmetric Loss

Prediction problems involving asymmetric loss functions arise routinely in many fields, yet the theory of optimal prediction under asymmetric loss is not well developed. We study the optimal prediction problem under general loss structures and characterize the optimal predictor. We compute the optimal predictor analytically in two leading tractable cases and show how to compute it numerically in less tractable cases. A key theme is that the conditionally optimal forecast is biased under asymmetric loss and that the conditionally optimal amount of bias is time varying in general and depends on higher order conditional moments. Thus, for example, volatility dynamics (e.g., GARCH effects) are relevant for optimal point prediction under asymmetric loss. More generally, even for models with linear conditionalmean structure, the optimal point predictor is in general nonlinear under asymmetric loss, which provides a link with the broader nonlinear time series literature.