Tests of Conditional Predictive Ability

Raffaella Giacomini and Halbert White
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Raffaella Giacomini: University of California, San Diego

No 2003-09, University of California at San Diego, Economics Working Paper Series from Department of Economics, UC San Diego

Abstract: We argue that the current framework for predictive ability testing (e.g., West, 1996) is not necessarily useful for real-time forecast selection, i.e., for assessing which of two competing forecasting methods will perform better in the future. We propose an alternative framework for out-of-sample comparison of predictive ability which delivers more practically relevant conclusions. Our approach is based on inference about conditional expectations of forecasts and forecast errors rather than the unconditional expectations that are the focus of the existing literature. We capture important determinants of forecast performance that are neglected in the existing literature by evaluating what we call the forecasting method (the model and the parameter estimation procedure), rather than just the forecasting model. Compared to previous approaches, our tests are valid under more general data assumptions (heterogeneity rather than stationarity) and estimation methods, and they can handle comparison of both nested and non-nested models, which is not currently possible. To illustrate the usefulness of the proposed tests, we compare the forecast performance of three leading parameter-reduction methods for macroeconomic forecasting using a large number of predictors: a sequential model selection approach, the "diffusion indexes" approach of Stock and Watson (2002), and the use of Bayesian shrinkage estimators.

Keywords: Forecast evaluation; asymptotic inference; parameter-reduction methods (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin, nep-lab and nep-rmg
Date: 2004-09-29
Note: oai:cdlib1.org:ucsdecon-1012
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Related works:
Working Paper: Tests of Conditional Predictive Ability (2003)
Working Paper: Tests of conditional predictive ability (2003)
Journal Article: Tests of Conditional Predictive Ability (2006)
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