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Robustifying Forecasts from Equilibrium-Correction Models

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  • David F. Hendry

    (Economcis Department, University of Oxford)

Abstract

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.

Suggested Citation

  • David F. Hendry, 2004. "Robustifying Forecasts from Equilibrium-Correction Models," Economics Papers 2004-W14, Economics Group, Nuffield College, University of Oxford.
    • Handle: RePEc:nuf:econwp:0414
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    File URL: http://www.nuff.ox.ac.uk/economics/papers/2004/w14/DFHEqCMRobust.pdf
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    References listed on IDEAS

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    Cited by:

    1. J. M. Kargbo, 2007. "Forecasting agricultural exports and imports in South Africa," Applied Economics, Taylor & Francis Journals, vol. 39(16), pages 2069-2084.

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