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Chapter 16 The Economic and Statistical Value of Forecast Combinations Under Regime Switching: An Application to Predictable US Returns

Forecasting in the Presence of Structural Breaks and Model Uncertainty

ISBN: 978-0-444-52942-8, eISBN: 978-1-84950-540-6

Publication date: 29 February 2008

Abstract

We address an interesting case – the predictability of excess US asset returns from macroeconomic factors within a flexible regime-switching VAR framework – in which the presence of regimes may lead to superior forecasting performance from forecast combinations. After documenting that forecast combinations provide gains in predictive accuracy and that these gains are statistically significant, we show that forecast combinations may substantially improve portfolio selection. We find that the best-performing forecast combinations are those that either avoid estimating the pooling weights or that minimize the need for estimation. In practice, we report that the best-performing combination schemes are based on the principle of relative past forecasting performance. The economic gains from combining forecasts in portfolio management applications appear to be large, stable over time, and robust to the introduction of realistic transaction costs.

Citation

Guidolin, M. and Fangzhou Na, C. (2008), "Chapter 16 The Economic and Statistical Value of Forecast Combinations Under Regime Switching: An Application to Predictable US Returns", Rapach, D.E. and Wohar, M.E. (Ed.) Forecasting in the Presence of Structural Breaks and Model Uncertainty (Frontiers of Economics and Globalization, Vol. 3), Emerald Group Publishing Limited, Leeds, pp. 595-655. https://doi.org/10.1016/S1574-8715(07)00216-3

Publisher

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Emerald Group Publishing Limited

Copyright © 2008, Emerald Group Publishing Limited