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Structural breaks and long memory in US inflation rates: Do they matter for forecasting?

  • Hyung, Namwon
  • Franses, Philip Hans
  • Penm, Jack

There is substantial evidence that several economic time series variables experience occasional structural breaks. At the same time, for some of these variables there is evidence of long memory. In particular, it seems that inflation rates have both features. One cause for this finding may be that the two features are difficult to distinguish using currently available econometric tools. Indeed, various recent studies show that neglecting occasional breaks may lead to a spurious finding of long-memory properties. In this paper we focus on this issue within the context of out-of-sample forecasting. First, we show that indeed data with breaks can be viewed as long-memory data. Next, we compare time series models with structural breaks, models with long-memory and linear autoregressive models for 23 monthly US inflation rates in terms of out-of-sample forecasting for various horizons. A key finding is that the linear models do not perform as well as the other two, and that the model with breaks and the model with long memory perform about equally well. We also examine their joint performance by combining the forecasts. A by-product of our empirical analysis is that we can relate the value of the long-memory parameter with the number of detected breaks, in which case we find a strong positive relationship.

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Article provided by Elsevier in its journal Research in International Business and Finance.

Volume (Year): 20 (2006)
Issue (Month): 1 (March)
Pages: 95-110

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Handle: RePEc:eee:riibaf:v:20:y:2006:i:1:p:95-110
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  1. Francis X. Diebold & Atsushi Inoue, 2000. "Long Memory and Regime Switching," NBER Technical Working Papers 0264, National Bureau of Economic Research, Inc.
  2. Perron, P. & Bai, J., 1995. "Estimating and Testing Linear Models with Multiple Structural Changes," Cahiers de recherche 9552, Universite de Montreal, Departement de sciences economiques.
  3. Hassler, Uwe & Wolters, Jurgen, 1995. "Long Memory in Inflation Rates: International Evidence," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(1), pages 37-45, January.
  4. Harvey, David I & Leybourne, Stephen J & Newbold, Paul, 1998. "Tests for Forecast Encompassing," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(2), pages 254-59, April.
  5. Baillie, Richard T., 1996. "Long memory processes and fractional integration in econometrics," Journal of Econometrics, Elsevier, vol. 73(1), pages 5-59, July.
  6. Robert F. Engle & Aaron D. Smith, 1999. "Stochastic Permanent Breaks," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 553-574, November.
  7. Nunes, Luis C. & Newbold, Paul & Chung-Ming Kuan, 1996. "Spurious number of breaks," Economics Letters, Elsevier, vol. 50(2), pages 175-178, February.
  8. Bai, Jushan, 1997. "Estimating Multiple Breaks One at a Time," Econometric Theory, Cambridge University Press, vol. 13(03), pages 315-352, June.
  9. Bos, Charles S. & Franses, Philip Hans & Ooms, Marius, 2002. "Inflation, forecast intervals and long memory regression models," International Journal of Forecasting, Elsevier, vol. 18(2), pages 243-264.
  10. Breidt, F. Jay & Crato, Nuno & de Lima, Pedro, 1998. "The detection and estimation of long memory in stochastic volatility," Journal of Econometrics, Elsevier, vol. 83(1-2), pages 325-348.
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