Combining Forecasts under Structural Breaks Using Graphical LASSO

Tae Hwy Lee and Ekaterina Seregina ()
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Ekaterina Seregina: Colby College

No 202310, Working Papers from University of California at Riverside, Department of Economics

Abstract: In this paper we develop a novel method of combining many forecasts based on a machine learning algorithm called Graphical LASSO (GL). We visualize forecast errors from different forecasters as a network of interacting entities and generalize network inference in the presence of common factor structure and structural breaks. First, we note that forecasters often use common information and hence make common mistakes, which makes the forecast errors exhibit common factor structures. We use the Factor Graphical LASSO (FGL, Lee and Seregina (2023)) to separate common forecast errors from the idiosyncratic errors and exploit sparsity of the precision matrix of the latter. Second, since the network of experts changes over time as a response to unstable environments such as recessions, it is unreasonable to assume constant forecast combination weights. Hence, we propose Regime-Dependent Factor Graphical LASSO (RD-FGL) that allows factor loadings and idiosyncratic precision matrix to be regime-dependent. We develop its scalable implementation using the Alternating Direction Method of Multipliers (ADMM) to estimate regime-dependent forecast combination weights. The empirical application to forecasting macroeconomic series using the data of the European Central Bank’s Survey of Professional Forecasters (ECB SPF) demonstrates superior performance of a combined forecast using FGL and RD-FGL.

Keywords: Common Forecast Errors; Regime Dependent Forecast Combination; Sparse Precision Matrix of Idiosyncratic Errors; Structural Breaks. (search for similar items in EconPapers)
JEL-codes: C13 C38 C55 (search for similar items in EconPapers)
Pages: 55 Pages
Date: 2023-09
New Economics Papers: this item is included in nep-big, nep-cmp, nep-for, nep-ger and nep-net
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https://economics.ucr.edu/repec/ucr/wpaper/202310.pdf First version, 2023 (application/pdf)

Related works:
Working Paper: Combining Forecasts under Structural Breaks Using Graphical LASSO (2023)
Working Paper: Combining Forecasts under Structural Breaks Using Graphical LASSO (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:ucr:wpaper:202310

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