Co-integration Constraint and Forecasting: An Empirical Examination

Jin-Lung (henry) Lin () and Ruey S Tsay

Journal of Applied Econometrics, 1996, vol. 11, issue 5, 519-38

Abstract: Does co-integration help long-term forecasts? In this paper, we use simulation, real data sets, and multi-step-ahead post-sample forecasts to study this question. Based on the square root of the trace of forecasting error-covariance matrix, we found that for simulated data imposing the 'correct' unit-root constraints implied by co-integration does improve the accuracy of forecasts. For real data sets, the answer is mixed. Imposing unit-root constraints suggested by co-integration tests produces better forecasts for some cases, but fares poorly for others. We give some explanations for the poor performance of co-integration in long-term forecasting and discuss the practical implications of the study. Finally, an adaptive forecasting procedure is found to perform well in one- to ten-step-ahead forecasts. Copyright 1996 by John Wiley & Sons, Ltd.

Date: 1996
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