Forecasting with Equilibrium-correction Models during Structural Breaks

Jennifer Castle, David Hendry and Nicholas Fawcett

No 408, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: When breaks occur, equilibrium-correction models (EqCMs) based on cointegration face forecasting problems. We investigate approaches to alleviate forecast failure following a location shift, including updating, intercept corrections, differencing, and estimating the future impact of an 'internal' break during its progress. Although updating can lead to a loss of cointegration when an EqCM suffers an equilibrium-mean shift, we show that updating can help when collinearities are changed by an 'external' break and the EqCM itself remains constant. Both mechanistic corrections help compared to just retaining a pre-break estimated model, but an estimated model of the break process could outperform. Throughout, we apply the approaches to the much-studied example of EqCMs for UK M1, and compare with updating a learning function as the break evolves.

Keywords: Forecasting; Location Shifts; Equilibrium-Correction Models (search for similar items in EconPapers)
JEL-codes: C1 C53 (search for similar items in EconPapers)
Date: 2008-10-01
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Citations: View citations in EconPapers (5)

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Journal Article: Forecasting with equilibrium-correction models during structural breaks (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:oxf:wpaper:408

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