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A new theory of forecasting

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  • Manganelli, Simone

Abstract

This paper argues that forecast estimators should minimise the loss function in a statistical, rather than deterministic, way. We introduce two new elements into the classical econometric analysis: a subjective guess on the variable to be forecasted and a probability reflecting the confidence associated to it. We then propose a new forecast estimator based on a test of whether the first derivatives of the loss function evaluated at the subjective guess are statistically different from zero. We show that the classical estimator is a special case of this new estimator, and that in general the two estimators are asymptotically equivalent. We illustrate the implications of this new theory with a simple simulation, an application to GDP forecast and an example of mean-variance portfolio selection. JEL Classification: C13, C53, G11

Suggested Citation

  • Manganelli, Simone, 2006. "A new theory of forecasting," Working Paper Series 584, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2006584
    Note: 196912
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    References listed on IDEAS

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    1. Graham Elliott & Allan Timmermann, 2016. "Economic Forecasting," Economics Books, Princeton University Press, edition 1, number 10740.
    2. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    3. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    4. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    5. Newey, Whitney K. & McFadden, Daniel, 1986. "Large sample estimation and hypothesis testing," Handbook of Econometrics, in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 36, pages 2111-2245, Elsevier.
    6. Simone Manganelli, 2004. "Asset Allocation by Variance Sensitivity Analysis," Journal of Financial Econometrics, Oxford University Press, vol. 2(3), pages 370-389.
    7. Granger, Clive W.J. & Machina, Mark J., 2006. "Forecasting and Decision Theory," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 1, chapter 2, pages 81-98, Elsevier.
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    Cited by:

    1. Andrés González & Kirstin Hubrich & Timo Teräsvirta, 2009. "Forecasting inflation with gradual regime shifts and exogenous information," CREATES Research Papers 2009-03, Department of Economics and Business Economics, Aarhus University.
    2. Keck, Alexander & Raubold, Alexander, 2006. "Forecasting trade," WTO Staff Working Papers ERSD-2006-05, World Trade Organization (WTO), Economic Research and Statistics Division.
    3. Robalo Marques, Carlos & Dias, Daniel & Santos Silva, João M. C., 2006. "Measuring the importance of the uniform nonsynchronization hypothesis," Working Paper Series 606, European Central Bank.

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    More about this item

    Keywords

    asset allocation; Decision under uncertainty; estimation; overfitting;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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