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Forecasting with equilibrium-correction models during structural breaks

  • Castle, Jennifer L.
  • Fawcett, Nicholas W.P.
  • Hendry, David F.

When location shifts occur, cointegration-based equilibrium-correction models (EqCMs) face forecasting problems. We consider alleviating such forecast failure by updating, intercept corrections, differencing, and estimating the future progress of an 'internal' break. Updating leads to a loss of cointegration when an EqCM suffers an equilibrium-mean shift, but helps when collinearities are changed by an 'external' break with the EqCM staying constant. Both mechanistic corrections help compared to retaining a pre-break estimated model, but an estimated model of the break process could outperform. We apply the approaches to EqCMs for UK M1, compared with updating a learning function as the break evolves.

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Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 158 (2010)
Issue (Month): 1 (September)
Pages: 25-36

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Handle: RePEc:eee:econom:v:158:y:2010:i:1:p:25-36
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