Forecast accuracy and economic gains from Bayesian model averaging using time‐varying weights

Several Bayesian model combination schemes, including some novel approaches that simultaneously allow for parameter uncertainty, model uncertainty and robust time‐varying model weights, are compared in terms of forecast accuracy and economic gains using financial and macroeconomic time series. The results indicate that the proposed time‐varying model weight schemes outperform other combination schemes in terms of predictive and economic gains. In an empirical application using returns on the S&P 500 index, time‐varying model weights provide improved forecasts with substantial economic gains in an investment strategy including transaction costs. Another empirical example refers to forecasting US economic growth over the business cycle. It suggests that time‐varying combination schemes may be very useful in business cycle analysis and forecasting, as these may provide an early indicator for recessions.