Forecasting VARMA processes: VAR models vs. subspace-based state space models

Segismundo Izquierdo (), Cesareo Hernandez and Juan del Hoyo
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Juan del Hoyo: University of Valladolid

No 271, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: VAR modelling is a frequent technique in econometrics for assumed linear processes. VAR modelling offers some desirable features such as relatively simple procedures for model specification and the possibility of making a quick and non-iterative maximum likelihood estimation of the system parameters. However, if the process under study follows a finite-order VARMA structure, it cannot be equivalently represented by any finite-order VAR model. On the other hand, a finite-order state space model can represent a finite-order VARMA process exactly, and subspace algorithms allow for a simple specification and quick non-iterative estimates. Given the previous facts, we test in this paper whether subspace-based state space models can provide better forecasts than VAR models when working with VARMA data generating processes. In a simulation study we generate identification samples from different VARMA data generating processes, obtain VAR-based and state-space-based models for each generating process and compare the predictive power of the obtained models. We also conduct a practical comparison (for two cointegrated economic time series) of the predictive power of Johansen restricted-VAR (VEC) models with the predictive power of state space models obtained by the CCA subspace algorithm, including a density forecasting analysis

Keywords: Forecasting; time series; subspace models (search for similar items in EconPapers)
JEL-codes: C32 C53 (search for similar items in EconPapers)
Date: 2006-07-04
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Persistent link: https://EconPapers.repec.org/RePEc:sce:scecfa:271

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