Combining Forecasts from Nested Models* |
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Authors: | Todd E Clark Michael W McCracken |
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Institution: | 1. Economic Research Department, Federal Reserve Bank of Kansas City, 1 Memorial Drive, Kansas City, MO 64198, USA (e‐mail: todd.e.clark@kc.frb.org);2. Research Division, Federal Reserve Bank of St Louis, P.O. Box 442, St Louis, MO 63166, USA (e‐mail: michael.w.mccracken@stls.frb.org) |
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Abstract: | Motivated by the common finding that linear autoregressive models often forecast better than models that incorporate additional information, this paper presents analytical, Monte Carlo and empirical evidence on the effectiveness of combining forecasts from nested models. In our analytics, the unrestricted model is true, but a subset of the coefficients is treated as being local‐to‐zero. This approach captures the practical reality that the predictive content of variables of interest is often low. We derive mean square error‐minimizing weights for combining the restricted and unrestricted forecasts. Monte Carlo and empirical analyses verify the practical effectiveness of our combination approach. |
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Keywords: | C53 C52 |
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