Parameter Instability and Forecasting Performance: A Monte Carlo Study

Anyfantakis, Costas; Caporale, Guglielmo Maria and Pittis, Nikitas (July 2004) Parameter Instability and Forecasting Performance: A Monte Carlo Study. Former Series > Working Paper Series > IHS Economics Series 160


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Abstract: This paper uses Monte Carlo techniques to assess the loss in terms of forecast accuracy which is incurred when the true DGP exhibits parameter instability which is either overlooked or incorrectly modelled. We find that the loss is considerable when a FCM is estimated instead of the true TVCM, this loss being an increasing function of the degree of persistence and of the variance of the process driving the slope coefficient. A loss is also incurred when a TVCM different from the correct one is specified, the resulting forecasts being even less accurate than those of a FCM. However, the loss can be minimised by selecting a TVCM which, although incorrect, nests the true one, more specifically an AR(1) model with a constant. Finally, there is hardly any loss resulting from using a TVCM when the underlying DGP is characterised by fixed coefficients.;

Item Type: IHS Series
Keywords: 'Fixed coefficient model' 'Time varying parameter models' 'Forecasting'
Classification Codes (e.g. JEL): G14, G15, C22
Date Deposited: 26 Sep 2014 10:38
Last Modified: 26 Sep 2019 16:52
ISBN: 1605-7996

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