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Forecasting with equilibrium-correction models during structural breaks

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  • Castle, Jennifer L.
  • Fawcett, Nicholas W.P.
  • Hendry, David F.

Abstract

When location shifts occur, cointegration-based equilibrium-correction models (EqCMs) face forecasting problems. We consider alleviating such forecast failure by updating, intercept corrections, differencing, and estimating the future progress of an 'internal' break. Updating leads to a loss of cointegration when an EqCM suffers an equilibrium-mean shift, but helps when collinearities are changed by an 'external' break with the EqCM staying constant. Both mechanistic corrections help compared to retaining a pre-break estimated model, but an estimated model of the break process could outperform. We apply the approaches to EqCMs for UK M1, compared with updating a learning function as the break evolves.

Suggested Citation

  • Castle, Jennifer L. & Fawcett, Nicholas W.P. & Hendry, David F., 2010. "Forecasting with equilibrium-correction models during structural breaks," Journal of Econometrics, Elsevier, vol. 158(1), pages 25-36, September.
    • Handle: RePEc:eee:econom:v:158:y:2010:i:1:p:25-36
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    More about this item

    Keywords

    Cointegration Equilibrium-correction Forecasting Location shifts Collinearity M1;

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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