Parameter Instability and Forecasting Performance. A Monte Carlo Study

Costas Anyfantakis, Guglielmo Maria Caporale and Nikitas Pittis ()
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Costas Anyfantakis: University of Piraeus

No 160, Economics Series from Institute for Advanced Studies

Abstract: This paper uses Monte Carlo techniques to assess the loss in terms of forecast accuracy which is incurred when the true DGP exhibits parameter instability which is either overlooked or incorrectly modelled. We find that the loss is considerable when a FCM is estimated instead of the true TVCM, this loss being an increasing function of the degree of persistence and of the variance of the process driving the slope coefficient. A loss is also incurred when a TVCM different from the correct one is specified, the resulting forecasts being even less accurate than those of a FCM. However, the loss can be minimised by selecting a TVCM which, although incorrect, nests the true one, more specifically an AR(1) model with a constant. Finally, there is hardly any loss resulting from using a TVCM when the underlying DGP is characterised by fixed coefficients.

Keywords: Fixed coefficient model; Time varying parameter models; Forecasting (search for similar items in EconPapers)
JEL-codes: C22 G14 G15 (search for similar items in EconPapers)
Pages: 16 pages
Date: 2004-07
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https://irihs.ihs.ac.at/id/eprint/1580 First version, 2004 (application/pdf)

Related works:
Journal Article: Parameter instability and forecasting performance: a Monte Carlo study (2008)
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