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Optimal Forecast Combination Under Regime Switching

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  • Elliott, Graham
  • Timmermann, Allan G

Abstract

This Paper proposes a new forecast combination method that lets the combination weights be driven by regime switching in a latent state variable. An empirical application that combines forecasts from survey data and time series models finds that the proposed regime switching combination scheme performs well for a variety of macroeconomic variables. Monte Carlo simulations shed light on the type of data generating processes for which the proposed combination method can be expected to perform better than a range of alternative combination schemes. Finally, we show how time-variations in the combination weights arise when the target variable and the predictors share a common factor structure driven by a hidden Markov process.

Suggested Citation

  • Elliott, Graham & Timmermann, Allan G, 2004. "Optimal Forecast Combination Under Regime Switching," CEPR Discussion Papers 4649, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4649
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    Keywords

    forecast combination; Markov switching; survey data; time-varying combination weights;

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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