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Robustifying Forecasts from Equilibrium-Correction Models

  • David F. Hendry

    ()

    (Economcis Department, University of Oxford)

In a non-stationary world subject to structural breaks, where model and mechanism differ, equilibrium-correction models are a risky device from which to forecast. Equilibrium shifts entail systematic forecast failure, and indeed forecasts will tend to move in the opposite direction to the data. A new explanation for the empirical success of second differencing is proposed. We consider model transformations based on additional differencing to reduce forecast-error biases, as usual at some cost in increased forecast-error variances. The analysis is illustrated by an empirical application to narrow money holdings in the UK.

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File URL: http://www.nuff.ox.ac.uk/economics/papers/2004/w14/DFHEqCMRobust.pdf
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Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2004-W14.

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Length: 30 pages
Date of creation: 01 Apr 2004
Date of revision:
Handle: RePEc:nuf:econwp:0414
Contact details of provider: Web page: http://www.nuff.ox.ac.uk/economics/

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  1. Hendry, David F. & Clements, Michael P., 2001. "Economic forecasting: some lessons from recent research," Working Paper Series 0082, European Central Bank.
  2. Sangjoon Kim & Neil Shephard, 1994. "Stochastic volatility: likelihood inference and comparison with ARCH models," Economics Papers 3., Economics Group, Nuffield College, University of Oxford.
  3. repec:cup:cbooks:9780521634809 is not listed on IDEAS
  4. Johansen, Søren, 1992. "A Representation of Vector Autoregressive Processes Integrated of Order 2," Econometric Theory, Cambridge University Press, vol. 8(02), pages 188-202, June.
  5. Clara Jørgensen & Hans Christian Kongsted & Anders Rahbek, 1996. "Trend-Stationarity in the I(2) Cointegration Model," Discussion Papers 96-12, University of Copenhagen. Department of Economics.
  6. Hendry, David F. & Ericsson, Neil R., 1991. "Modeling the demand for narrow money in the United Kingdom and the United States," European Economic Review, Elsevier, vol. 35(4), pages 833-881, May.
  7. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 1999. "The Generalized Dynamic Factor Model: Identification and Estimation," CEPR Discussion Papers 2338, C.E.P.R. Discussion Papers.
  8. Makridakis, Spyros & Hibon, Michele, 2000. "The M3-Competition: results, conclusions and implications," International Journal of Forecasting, Elsevier, vol. 16(4), pages 451-476.
  9. repec:cup:cbooks:9780521632423 is not listed on IDEAS
  10. Melino, Angelo & Turnbull, Stuart M., 1990. "Pricing foreign currency options with stochastic volatility," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 239-265.
  11. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164, March.
  12. Bontemps, Christophe & Mizon, Grayham E., 2001. "Congruence and encompassing," Discussion Paper Series In Economics And Econometrics 0107, Economics Division, School of Social Sciences, University of Southampton.
  13. Francis X. Diebold & Jose A. Lopez, 1995. "Forecast evaluation and combination," Research Paper 9525, Federal Reserve Bank of New York.
  14. repec:cup:etheor:v:8:y:1992:i:2:p:188-202 is not listed on IDEAS
  15. Paruolo, Paolo, 1996. "On the determination of integration indices in I(2) systems," Journal of Econometrics, Elsevier, vol. 72(1-2), pages 313-356.
  16. Michael P. Clements & David F. Hendry, 2001. "Forecasting Non-Stationary Economic Time Series," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262531895, June.
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