DP4636 Forecasting Time Series Subject to Multiple Structural Breaks
|Author(s):||M Hashem Pesaran, Davide Pettenuzzo, Allan Timmermann|
|Publication Date:||September 2004|
|Keyword(s):||Bayesian model averaging, forecasting, hierarchical hidden Markov Chain Model, structural breaks|
|JEL(s):||C11, C15, C53|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=4636|
This Paper provides a novel approach to forecasting time series subject to discrete structural breaks. We propose a Bayesian estimation and prediction procedure that allows for the possibility of new breaks over the forecast horizon, taking account of the size and duration of past breaks (if any) by means of a hierarchical hidden Markov chain model. Predictions are formed by integrating over the hyper parameters from the meta distributions that characterize the stochastic break point process. In an application to US Treasury bill rates, we find that the method leads to better out-of-sample forecasts than alternative methods that ignore breaks, particularly at long horizons.