Robustifying Forecasts from Equilibrium-Correction Systems.

Journal article

Abstract:: Cointegration analysis has led to equilibrium-correction econometric systems being ubiquitous. But 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, as forecasts will tend to move in the opposite direction to data. We explain the empirical success of second-differenced devices and of model transformations based on additional differencing as reducing forecast-error biases, at some cost in increased forecast-error variances. The analysis is illustrated by an empirical application to narrow money holdings in the UK.

Files:: EqCMRobust04.pdf

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Copyright holder:: Elsevier BV
Notes:: Copyright 2005 Elsevier B.V. All rights reserved. NOTICE: this is the author's version of a work that was accepted for publication in Journal of Econometrics. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Econometrics, 135, 1-2, (November-December 2006) DOI#10.1016/j.jeconom.2005.07.029

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