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Forecasting with Equilibrium-correction Models during Structural Breaks

Author

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  • Jennifer Castle
  • David Hendry
  • Nicholas W.P. Fawcett

Abstract

When breaks occur, equilibrium-correction models (EqCMs) based on cointegration face forecasting problems. We investigate approaches to alleviate forecast failure following a location shift, including updating, intercept corrections, differencing, and estimating the future impact of an 'internal' break during its progress. Although updating can lead to a loss of cointegration when an EqCM suffers an equilibrium-mean shift, we show that updating can help when collinearities are changed by an 'external' break and the EqCM itself remains constant. Both mechanistic corrections help compared to just retaining a pre-break estimated model, but an estimated model of the break process could outperform. Throughout, we apply the approaches to the much-studied example of EqCMs for UK M1, and compare with updating a learning function as the break evolves.

Suggested Citation

  • Jennifer Castle & David Hendry & Nicholas W.P. Fawcett, 2008. "Forecasting with Equilibrium-correction Models during Structural Breaks," Economics Series Working Papers 408, University of Oxford, Department of Economics.
  • Handle: RePEc:oxf:wpaper:408
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    File URL: http://www.economics.ox.ac.uk/materials/working_papers/paper408.pdf
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    References listed on IDEAS

    as
    1. Clements, Michael P. & Hendry, David F., 2006. "Forecasting with Breaks," Handbook of Economic Forecasting, Elsevier.
    2. Hendry, David F & Doornik, Jurgen A, 1994. "Modelling Linear Dynamic Econometric Systems," Scottish Journal of Political Economy, Scottish Economic Society, vol. 41(1), pages 1-33, February.
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    5. Perron, Pierre, 1989. "The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis," Econometrica, Econometric Society, vol. 57(6), pages 1361-1401, November.
    6. David F. Hendry & Carlos Santos, 2005. "Regression Models with Data-based Indicator Variables," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(5), pages 571-595, October.
    7. Granger, C. W. J., 1981. "Some properties of time series data and their use in econometric model specification," Journal of Econometrics, Elsevier, vol. 16(1), pages 121-130, May.
    8. Clements,Michael & Hendry,David, 1998. "Forecasting Economic Time Series," Cambridge Books, Cambridge University Press, number 9780521632423, May.
    9. Engle, Robert & Granger, Clive, 2015. "Co-integration and error correction: Representation, estimation, and testing," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 39(3), pages 106-135.
    10. Michael P. Clements & David F. Hendry, 2005. "Guest Editors' Introduction: Information in Economic Forecasting," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 67(s1), pages 713-753, December.
    11. Hendry, David F., 2006. "Robustifying forecasts from equilibrium-correction systems," Journal of Econometrics, Elsevier, vol. 135(1-2), pages 399-426.
    12. David F. Hendry & Katarina Juselius, 2001. "Explaining Cointegration Analysis: Part II," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 75-120.
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    Citations

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    Cited by:

    1. Castle, Jennifer L. & Clements, Michael P. & Hendry, David F., 2015. "Robust approaches to forecasting," International Journal of Forecasting, Elsevier, vol. 31(1), pages 99-112.
    2. Ericsson, Neil R., 2017. "How biased are U.S. government forecasts of the federal debt?," International Journal of Forecasting, Elsevier, vol. 33(2), pages 543-559.
    3. Rocha, Jordano Vieira & Pereira, Pedro L. Valls, 2015. "Forecast comparison with nonlinear methods for Brazilian industrial production," Textos para discussão 397, FGV/EESP - Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).
    4. Ericsson, Neil R., 2016. "Eliciting GDP forecasts from the FOMC’s minutes around the financial crisis," International Journal of Forecasting, Elsevier, vol. 32(2), pages 571-583.
    5. repec:spr:jbuscr:v:12:y:2016:i:1:d:10.1007_s41549-016-0005-2 is not listed on IDEAS
    6. David F. Hendry, 2011. "Empirical Economic Model Discovery and Theory Evaluation," Rationality, Markets and Morals, Frankfurt School Verlag, Frankfurt School of Finance & Management, vol. 2(46), October.
    7. Hendry, David F. & Mizon, Grayham E., 2014. "Unpredictability in economic analysis, econometric modeling and forecasting," Journal of Econometrics, Elsevier, vol. 182(1), pages 186-195.

    More about this item

    Keywords

    Forecasting; Location Shifts; Equilibrium-Correction Models;

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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