Discussion paper

DP11391 Forecast Rationality Tests in the Presence of Instabilities, With Applications to Federal Reserve and Survey Forecasts

This paper proposes a framework to implement regression-based tests of predictive ability in unstable environments, including, in particular, forecast unbiasedness and efficiency tests, commonly referred to as tests of forecast rationality. Our framework is general: it can be applied to model-based forecasts obtained either with recursive or rolling window estimation schemes, as well as to forecasts that are model-free. The proposed tests provide more evidence against forecast rationality than previously found in the Federal Reserve's Greenbook forecasts as well as survey-based private forecasts. It confirms, however, that the Federal Reserve has additional information about current and future states of the economy relative to market participants.

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Citation

Rossi, B and T Sekhposyan (2016), ‘DP11391 Forecast Rationality Tests in the Presence of Instabilities, With Applications to Federal Reserve and Survey Forecasts‘, CEPR Discussion Paper No. 11391. CEPR Press, Paris & London. https://cepr.org/publications/dp11391