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Forecast comparisons in unstable environments

  • Raffaella Giacomini

    (UCL|CEMMAP and Department of Economics, Duke University, Durham, NC, USA)

  • Barbara Rossi

    (UCL|CEMMAP and Department of Economics, Duke University, Durham, NC, USA)

We propose new methods for comparing the out-of-sample forecasting performance of two competing models in the presence of possible instabilities. The main idea is to develop a measure of the relative local forecasting performance for the two models, and to investigate its stability over time by means of statistical tests. We propose two tests (the Fluctuation test and the One-Time Reversal test) that analyze the evolution of the models' relative performance over historical samples. In contrast to previous approaches to forecast comparison, which are based on measures of global performance, we focus on the entire time path of the models' relative performance, which may contain useful information that is lost when looking for the model that forecasts best on average. We apply our tests to the analysis of the time variation in the out-of-sample forecasting performance of monetary models of exchange rate determination relative to the random walk. Copyright © 2010 John Wiley & Sons, Ltd.

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Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 25 (2010)
Issue (Month): 4 ()
Pages: 595-620

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Handle: RePEc:jae:japmet:v:25:y:2010:i:4:p:595-620
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  1. Raffaella Giacomini & Halbert White, 2006. "Tests of Conditional Predictive Ability," Econometrica, Econometric Society, vol. 74(6), pages 1545-1578, November.
  2. Lutz Kilian & Mark P. Taylor, 2001. "Why is it so difficult to beat the Random Walk Forecast of Exchange Rates?," Tinbergen Institute Discussion Papers 01-031/4, Tinbergen Institute.
  3. Ploberger, Werner & Kramer, Walter, 1992. "The CUSUM Test with OLS Residuals," Econometrica, Econometric Society, vol. 60(2), pages 271-85, March.
  4. Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation for Research in Economics, Yale University.
  5. Diebold, Francis X & Mariano, Roberto S, 1995. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(3), pages 253-63, July.
  6. Barbara Rossi, 2005. "Are Exchange Rates Really Random Walks? Some Evidence Robust to Parameter Instability," International Finance 0503006, EconWPA.
  7. Timmermann, Allan, 2008. "Elusive return predictability," International Journal of Forecasting, Elsevier, vol. 24(1), pages 1-18.
  8. Todd E. Clark & Michael W. McCracken, 2000. "Tests of Equal Forecast Accuracy and Encompassing for Nested Models," Econometric Society World Congress 2000 Contributed Papers 0319, Econometric Society.
  9. Chu, C.S.J. & Hornik, K. & Kuan, C.M., 1993. "Mosum Tests for Parameter Constancy," Papers 9319, Southern California - Department of Economics.
  10. Barbara Rossi, 2005. "Testing Long-Horizon Predictive Ability With High Persistence, And The Meese-Rogoff Puzzle," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(1), pages 61-92, 02.
  11. Jushan Bai, 1997. "Estimation Of A Change Point In Multiple Regression Models," The Review of Economics and Statistics, MIT Press, vol. 79(4), pages 551-563, November.
  12. Inoue, Atsushi & Kilian, Lutz, 2003. "On the selection of forecasting models," Working Paper Series 0214, European Central Bank.
  13. 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.
  14. Graham Elliott & Allan Timmermann, 2005. "Optimal Forecast Combination Under Regime Switching ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 46(4), pages 1081-1102, November.
  15. Todd E. Clark & Kenneth D. West, 2004. "Using out-of-sample mean squared prediction errors to test the Martingale difference hypothesis," Research Working Paper RWP 04-03, Federal Reserve Bank of Kansas City.
  16. Raffaella Giacomini & Barbara Rossi, 2014. "Model comparisons in unstable environments," Economics Working Papers 1437, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2015.
  17. Rossi, Barbara, 2002. "Optimal Tests for Nested Model Selection with Underlying Parameter Instability," Working Papers 02-05, Duke University, Department of Economics.
  18. James H. Stock & Mark W. Watson, 2001. "Forecasting Output and Inflation: The Role of Asset Prices," NBER Working Papers 8180, National Bureau of Economic Research, Inc.
  19. Mc Cracken, Michael W., 2000. "Robust out-of-sample inference," Journal of Econometrics, Elsevier, vol. 99(2), pages 195-223, December.
  20. Kenneth S. Rogoff & Vania Stavrakeva, 2008. "The Continuing Puzzle of Short Horizon Exchange Rate Forecasting," NBER Working Papers 14071, National Bureau of Economic Research, Inc.
  21. West, K.D., 1994. "Asymptotic Inference About Predictive Ability," Working papers 9417, Wisconsin Madison - Social Systems.
  22. Andrews, Donald W K, 1991. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Econometrica, Econometric Society, vol. 59(3), pages 817-58, May.
  23. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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