Bayesian Model Averaging under Regime Switching with Application to Cyclical Macro Variable Forecasting

Bayesian Model Averaging under Regime Switching with Application to Cyclical Macro Variable Forecasting

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Article ID: iaor2016941
Volume: 35
Issue: 3
Start Page Number: 250
End Page Number: 262
Publication Date: Apr 2016
Journal: Journal of Forecasting
Authors:
Keywords: forecasting: applications, statistics: empirical, time series: forecasting methods
Abstract:

Model uncertainty and recurrent or cyclical structural changes in macroeconomic time series dynamics are substantial challenges to macroeconomic forecasting. This paper discusses a macro variable forecasting methodology that combines model uncertainty and regime switching simultaneously. The proposed predictive regression specification permits both regime switching of the regression parameters and uncertainty about the inclusion of forecasting variables by employing Bayesian model averaging. In an empirical exercise involving quarterly US inflation, we observed that our Bayesian model averaging with regime switching leads to substantial improvements in forecast performance, particularly in the medium horizon (two to four quarters).

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