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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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  1. Raffaella Giacomini & Barbara Rossi, 2009. "Model Comparisons in Unstable Environments," Working Papers 09-10, Duke University, Department of Economics.
  2. 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.
  3. James H. Stock & Mark W. Watson, 2001. "Forecasting output and inflation: the role of asset prices," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Lutz Kilian & Mark P. Taylor, 2001. "Why Is It So Difficult to Beat the Random Walk Forecast of Exchange Rates?," Working Papers 464, Research Seminar in International Economics, University of Michigan.
  5. West, K.D., 1994. "Asymptotic Inference About Predictive Ability," Working papers 9417, Wisconsin Madison - Social Systems.
  6. Raffaella Giacomini & Halbert White, 2006. "Tests of Conditional Predictive Ability," Econometrica, Econometric Society, vol. 74(6), pages 1545-1578, November.
  7. 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.
  8. Inoue, Atsushi & Kilian, Lutz, 2003. "On the selection of forecasting models," Working Paper Series 0214, European Central Bank.
  9. 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.
  10. Rossi, Barbara, 2002. "Optimal Tests for Nested Model Selection with Underlying Parameter Instability," Working Papers 02-05, Duke University, Department of Economics.
  11. Todd E. Clark & Michael W. McCracken, 1999. "Tests of equal forecast accuracy and encompassing for nested models," Research Working Paper 99-11, Federal Reserve Bank of Kansas City.
  12. 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.
  13. 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.
  14. Francis X. Diebold & Robert S. Mariano, 1994. "Comparing Predictive Accuracy," NBER Technical Working Papers 0169, National Bureau of Economic Research, Inc.
  15. Timmermann, Allan, 2008. "Elusive return predictability," International Journal of Forecasting, Elsevier, vol. 24(1), pages 1-18.
  16. Mc Cracken, Michael W., 2000. "Robust out-of-sample inference," Journal of Econometrics, Elsevier, vol. 99(2), pages 195-223, December.
  17. 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.
  18. Chu, C.S.J. & Hornik, K. & Kuan, C.M., 1993. "Mosum Tests for Parameter Constancy," Papers 9319, Southern California - Department of Economics.
  19. 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.
  20. Donald W.K. Andrews, 1988. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Cowles Foundation Discussion Papers 877R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1989.
  21. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-56, July.
  22. Ploberger, Werner & Kramer, Walter, 1992. "The CUSUM Test with OLS Residuals," Econometrica, Econometric Society, vol. 60(2), pages 271-85, March.
  23. Rossi, Barbara, 2002. "Testing Long-horizon Predictive Ability with High Persistence, and the Meese-Rogoff Puzzle," Working Papers 02-10, Duke University, Department of Economics.
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