DP6158 Economic Forecasting

Author(s): Graham Elliott, Allan Timmermann
Publication Date: March 2007
Keyword(s): economic forecasting, forecast evaluation, loss function
JEL(s): C53
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6158

Forecasts guide decisions in all areas of economics and finance and their value can only be understood in relation to, and in the context of, such decisions. We discuss the central role of the loss function in helping determine the forecaster's objectives and use this to present a unified framework for both the construction and evaluation of forecasts. Challenges arise from the explosion in the sheer volume of predictor variables under consideration and the forecaster's ability to entertain an endless array of functional forms and time-varying specifications, none of which may coincide with the `true' model. Methods for comparing the forecasting performance of pairs of models or evaluating the ability of the best of many models to beat a benchmark specification are also reviewed.