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Forecast Comparisons in Unstable Environments

  • Giacomini, Raffaella
  • Rossi, Barbara

We propose new methods for comparing the relative 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 ìlocal forecasting performanceî for the two models, and to investigate its stability over time by means of statistical tests. We propose two tests (the ìFluctuation testî and the test against a ìOne-time Reversalî) that analyze the evolution of the modelsí relative performance over historical samples. In contrast to previous approaches to forecast comparison, which are based on measures of ìglobal performanceî, we focus on the entire time path of the modelsí 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.

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Paper provided by Duke University, Department of Economics in its series Working Papers with number 08-04.

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Length: 30 Pages
Date of creation: 2008
Date of revision:
Handle: RePEc:duk:dukeec:08-4
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  2. Kilian, Lutz & Taylor, Mark P., 2001. "Why is it so difficult to beat the random walk forecast of exchange rates?," Working Paper Series 0088, European Central Bank.
  3. Giacomini, Raffaella & White, Halbert, 2003. "Tests of Conditional Predictive Ability," University of California at San Diego, Economics Working Paper Series qt5jk0j5jh, Department of Economics, UC San Diego.
  4. Rossi, Barbara, 2006. "Are Exchange Rates Really Random Walks? Some Evidence Robust To Parameter Instability," Macroeconomic Dynamics, Cambridge University Press, vol. 10(01), pages 20-38, February.
  5. 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.
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  12. Barbara Rossi & Raffaella Giacomini, 2010. "Model Comparisons in Unstable Environments," Working Papers 10-29, Duke University, Department of Economics.
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  18. 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.
  19. Perron, P. & Bai, J., 1995. "Estimating and Testing Linear Models with Multiple Structural Changes," Cahiers de recherche 9552, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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