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What causes the forecasting failure of Markov-Switching models? A Monte Carlo study

Marie Bessec () and Othman Bouabdallah
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Othman Bouabdallah: EUREQua - University Paris Panthéon Sorbonne

Econometrics from University Library of Munich, Germany

Abstract: This paper explores the forecasting abilities of Markov-Switching models. Although MS models generally display a superior in-sample fit relative to linear models, the gain in prediction remains small. We confirm this result using simulated data for a wide range of specifications by applying several tests of forecast accuracy and encompassing robust to nested models. In order to explain this poor performance, we use a forecasting error decomposition. We identify four components and derive their analytical expressions in different MS specifications. The relative contribution of each source is assessed through Monte Carlo simulations. We find that the main source of error is due to the misclassification of future regimes.

Keywords: Forecasting; Regime Shifts; Markov-Switching. (search for similar items in EconPapers)
JEL-codes: C22 C32 C53 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2005-03-22
New Economics Papers: this item is included in nep-ecm and nep-ets
Note: Type of Document - pdf; pages: 19
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