An Open-model Forecast-error Taxonomy

David Hendry and Grayham Mizon

No 552, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: We develop forecast-error taxonomies when there are unmodeled variables, forecast 'off-line'. We establish three surprising results. Even when an open system is correctly specified in-sample with zero intercepts, despite known future values of strongly exogenous variables, changes in dynamics can induce forecast failure when they have non-zero means. The additional impact on forecast failure of incorrectly omitting such variables depends only on shifts in their means. With no such shifts, there is no reduction in forecast failure from forecasting unmodeled variables relative to omitting them in 1-step or multi-step forecasts. Simulation illustrations confirm these results.

Keywords: Forecasting; Forecast-error taxonomies; Location shifts; Open models (search for similar items in EconPapers)
JEL-codes: C22 C51 (search for similar items in EconPapers)
Date: 2011-06-01
New Economics Papers: this item is included in nep-cba and nep-for
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