Properties of Optimal Forecasts

Allan Timmermann and Andrew Patton

No 234, Econometric Society 2004 North American Winter Meetings from Econometric Society

Abstract: Evaluation of forecast optimality in economics and finance has almost exclusively been conducted under the assumption of mean squared error loss. Under this loss function optimal forecasts should be unbiased and forecast errors should be serially uncorrelated at the single period horizon with increasing variance as the forecast horizon grows. Using analytical results, we show in this paper that all the standard properties of optimal forecasts can be invalid under asymmetric loss and nonlinear data generating processes and thus may be very misleading as a benchmark for an optimal forecast. Our theoretical results suggest that many of the conclusions in the empirical literature concerning suboptimality of forecasts could be premature. We extend the properties that an optimal forecast should have to a more general setting than previously considered in the literature. We also present results on forecast error properties that may be tested when the forecaster's loss function is unknown, and introduce a change of measure, following which the optimum forecast errors for general loss functions have the same properties as optimum errors under MSE loss

Keywords: forecast evaluation; loss function; rationality; efficient markets (search for similar items in EconPapers)
JEL-codes: C22 C52 C53 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (13)

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http://repec.org/esNAWM04/up.3667.1048860005.pdf (application/pdf)

Related works:
Working Paper: Properties of Optimal Forecasts (2003)
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Persistent link: https://EconPapers.repec.org/RePEc:ecm:nawm04:234

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