How Good are Out of Sample Forecasting Tests on DSGE Models?

25 Pages Posted: 10 Nov 2014

See all articles by Patrick Minford

Patrick Minford

Cardiff University Business School; Centre for Economic Policy Research (CEPR)

Yongdeng Xu

Cardiff University - Cardiff Business School - Economics Section

Peng Zhou

Cardiff University - Cardiff Business School; Cardiff Metropolitan University

Date Written: November 2014

Abstract

Out-of-sample forecasting tests of DSGE models against time-series benchmarks such as an unrestricted VAR are increasingly used to check a) the specification b) the forecasting capacity of these models. We carry out a Monte Carlo experiment on a widely-used DSGE model to investigate the power of these tests. We find that in specification testing they have weak power relative to an in-sample indirect inference test; this implies that a DSGE model may be badly mis-specified and still improve forecasts from an unrestricted VAR. In testing forecasting capacity they also have quite weak power, particularly on the lefthand tail. By contrast a model that passes an indirect inference test of specification will almost definitely also improve on VAR forecasts.

Keywords: DSGE, forecast performance, indirect inference, out of sample forecasts, specification tests, VAR

JEL Classification: E10, E17

Suggested Citation

Minford, Patrick and Xu, Yongdeng and Zhou, Peng, How Good are Out of Sample Forecasting Tests on DSGE Models? (November 2014). CEPR Discussion Paper No. DP10239. Available at SSRN: https://ssrn.com/abstract=2521460

Patrick Minford (Contact Author)

Cardiff University Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
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+44 29 2087 5728 (Phone)
+44 29 2087 4419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Yongdeng Xu

Cardiff University - Cardiff Business School - Economics Section ( email )

Cardiff CF10 3EU
United Kingdom

Peng Zhou

Cardiff University - Cardiff Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom

Cardiff Metropolitan University ( email )

Western Avenue
Cardiff, CF5 2YB
United Kingdom

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