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Model confidence sets for forecasting models

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  • Peter Reinhard Hansen
  • Asger Lunde
  • James M. Nason

Abstract

The paper introduces the model confidence set (MCS) and applies it to the selection of forecasting models. An MCS is a set of models that is constructed so that it will contain the ?best? forecasting model, given a level of confidence. Thus, an MCS is analogous to a confidence interval for a parameter. The MCS acknowledges the limitations of the data so that uninformative data yield an MCS with many models, whereas informative data yield an MCS with only a few models. We revisit the empirical application in Stock and Watson (1999) and apply the MCS procedure to their set of inflation forecasts. In the first pre-1984 subsample we obtain an MCS that contains only a few models, notably versions of the Solow-Gordon Phillips curve. On the other hand, the second post-1984 subsample contains little information and results in a large MCS. Yet, the random walk forecast is not contained in the MCS for either of the samples. This outcome shows that the random walk forecast is inferior to inflation forecasts based on Phillips curve-like relationships.

Suggested Citation

  • Peter Reinhard Hansen & Asger Lunde & James M. Nason, 2005. "Model confidence sets for forecasting models," FRB Atlanta Working Paper 2005-07, Federal Reserve Bank of Atlanta.
    • Handle: RePEc:fip:fedawp:2005-07
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    References listed on IDEAS

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    1. Andrew Atkeson & Lee E. Ohanian, 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 25(Win), pages 2-11.
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    1. McAleer, Michael & Jimenez-Martin, Juan-Angel & Perez-Amaral, Teodosio, 2013. "GFC-robust risk management strategies under the Basel Accord," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 97-111.
    2. Becker, Ralf & Clements, Adam E., 2008. "Are combination forecasts of S&P 500 volatility statistically superior?," International Journal of Forecasting, Elsevier, vol. 24(1), pages 122-133.
    3. Peter Reinhard Hansen & Asger Lunde & James M. Nason, 2003. "Choosing the Best Volatility Models: The Model Confidence Set Approach," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 65(s1), pages 839-861, December.
    4. Andersen, Torben G. & Bollerslev, Tim & Christoffersen, Peter F. & Diebold, Francis X., 2006. "Volatility and Correlation Forecasting," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 1, chapter 15, pages 777-878, Elsevier.
    5. Michiel de Pooter & Francesco Ravazzolo & Dick van Dijk, 2010. "Term structure forecasting using macro factors and forecast combination," Working Paper 2010/01, Norges Bank.
    6. James M. Nason & Gregor W. Smith, 2008. "Identifying the new Keynesian Phillips curve," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 23(5), pages 525-551.
    7. Massimiliano Caporin & Michael McAleer, 2010. "Ranking Multivariate GARCH Models by Problem Dimension," CARF F-Series CARF-F-219, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    8. Bhardwaj, Geetesh & Swanson, Norman R., 2006. "An empirical investigation of the usefulness of ARFIMA models for predicting macroeconomic and financial time series," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 539-578.
    9. Andrew J. Patton & Kevin Sheppard, 2008. "Evaluating Volatility and Correlation Forecasts," OFRC Working Papers Series 2008fe22, Oxford Financial Research Centre.
    10. Afanasyev, Dmitriy O. & Fedorova, Elena A., 2019. "On the impact of outlier filtering on the electricity price forecasting accuracy," Applied Energy, Elsevier, vol. 236(C), pages 196-210.
    11. Davide De Gaetano, 2016. "Forecast Combinations For Realized Volatility In Presence Of Structural Breaks," Departmental Working Papers of Economics - University 'Roma Tre' 0208, Department of Economics - University Roma Tre.
    12. Patton, Andrew J. & Sheppard, Kevin, 2009. "Optimal combinations of realised volatility estimators," International Journal of Forecasting, Elsevier, vol. 25(2), pages 218-238.
    13. Caporin, M. & McAleer, M.J., 2010. "Model Selection and Testing of Conditional and Stochastic Volatility Models," Econometric Institute Research Papers EI 2010-57, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    14. Romano, Joseph P. & Shaikh, Azeem M. & Wolf, Michael, 2008. "Formalized Data Snooping Based On Generalized Error Rates," Econometric Theory, Cambridge University Press, vol. 24(2), pages 404-447, April.
    15. Hansen, Peter Reinhard & Lunde, Asger, 2006. "Consistent ranking of volatility models," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 97-121.
    16. Jörg Döpke & Ulrich Fritsche, 2006. "Growth and inflation forecasts for Germany a panel-based assessment of accuracy and efficiency," Empirical Economics, Springer, vol. 31(3), pages 777-798, September.
    17. Christian Dreger & Konstantin Arkadievich Kholodilin, 2013. "Forecasting Private Consumption by Consumer Surveys," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 32(1), pages 10-18, January.
    18. Bordignon, Silvano & Bunn, Derek W. & Lisi, Francesco & Nan, Fany, 2013. "Combining day-ahead forecasts for British electricity prices," Energy Economics, Elsevier, vol. 35(C), pages 88-103.

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