The forecast combination puzzle: a simple theoretical explanation

Gerda Claeskens, Jan Magnus (), Andrey Vasnev and Wendun Wang

No 532152, Working Papers of Department of Decision Sciences and Information Management, Leuven from KU Leuven, Faculty of Economics and Business (FEB), Department of Decision Sciences and Information Management, Leuven

Abstract: This paper offers a theoretical explanation for the stylized fact that forecast combinations with estimated optimal weights often perform poorly in applications. The properties of the forecast combination are typically derived under the assumption that the weights are fixed, while in practice they need to be estimated. If the fact that the weights are random rather than fixed is taken into account during the optimality derivation, then the forecast combination will be biased (even when the original forecasts are unbiased) and its variance is larger than in the fixed-weights case. In particular, there is no guarantee that the 'optimal' forecast combination will be better than the equal-weights case or even improve on the original forecasts. We provide the underlying theory, some special cases, and a numerical illustration.

Keywords: Forecast combination; Optimal weights (search for similar items in EconPapers)
Date: 2016-02
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Published in FEB Research Report KBI_1604

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Related works:
Journal Article: The forecast combination puzzle: A simple theoretical explanation (2016)
Working Paper: The Forecast Combination Puzzle: A Simple Theoretical Explanation (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:ete:kbiper:532152

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