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Nested forecast model comparisons: a new approach to testing equal accuracy

Listed author(s):
  • Todd E. Clark
  • Michael W. McCracken

This paper develops bootstrap methods for testing whether, in a finite sample, competing out-of-sample forecasts from nested models are equally accurate. Most prior work on forecast tests for nested models has focused on a null hypothesis of equal accuracy in population basically, whether coefficients on the extra variables in the larger, nesting model are zero. We instead use an asymptotic approximation that treats the coefficients as non-zero but small, such that, in a finite sample, forecasts from the small model are expected to be as accurate as forecasts from the large model. Under that approximation, we derive the limiting distributions of pairwise tests of equal mean square error, and develop bootstrap methods for estimating critical values. Monte Carlo experiments show that our proposed procedures have good size and power properties for the null of equal finite-sample forecast accuracy. We illustrate the use of the procedures with applications to forecasting stock returns and inflation.

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File URL: http://www.kansascityfed.org/PUBLICAT/RESWKPAP/PDF/RWP09-11.pdf
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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 09-11.

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Date of creation: 2009
Handle: RePEc:fip:fedkrw:rwp09-11
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  1. Lance J. Bachmeier & Norman R. Swanson, 2005. "Predicting Inflation: Does The Quantity Theory Help?," Economic Inquiry, Western Economic Association International, vol. 43(3), pages 570-585, July.
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  3. Michael W. McCracken & Todd E. Clark, 2003. "The Predictive Content of the Output Gap for Inflation: Resolving In-Sample and Out-of-Sample Evidence," Computing in Economics and Finance 2003 183, Society for Computational Economics.
  4. Corradi, Valentina & Swanson, Norman R., 2002. "A consistent test for nonlinear out of sample predictive accuracy," Journal of Econometrics, Elsevier, vol. 110(2), pages 353-381, October.
  5. 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.
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