A Non-Linear Forecast Combination Procedure for Binary Outcomes

40 Pages Posted: 4 Feb 2015

See all articles by Kajal Lahiri

Kajal Lahiri

State University of New York (SUNY) at Albany, College of Arts and Sciences, Economics

Liu Yang

Nanjing University - School of Business; State University of New York (SUNY) at Albany, College of Arts and Sciences, Economics

Date Written: January 30, 2015

Abstract

We develop a non-linear forecast combination rule based on copulas that incorporate the dynamic interaction between individual predictors. This approach is optimal in the sense that the resulting combined forecast produces the highest discriminatory power as measured by the receiver operating characteristic (ROC) curve. Under additional assumptions, this rule is shown to be equivalent to the quintessential linear combination scheme. To illustrate its usefulness, we apply this methodology to optimally aggregate two currently used leading indicators — the ISM new order diffusion index and the yield curve spread — to predict economic recessions in the United States. We also examine the sources of forecasting gains using a counterfactual experimental set up.

Keywords: receiver operating characteristic curve, Copula, Bayesian methods, Markov chain Monte Carlo, yield spread, ISM diffusion index

JEL Classification: C110, C150, C380, C530, E370

Suggested Citation

Lahiri, Kajal and Yang, Liu, A Non-Linear Forecast Combination Procedure for Binary Outcomes (January 30, 2015). CESifo Working Paper Series No. 5175. Available at SSRN: https://ssrn.com/abstract=2559742

Kajal Lahiri (Contact Author)

State University of New York (SUNY) at Albany, College of Arts and Sciences, Economics ( email )

Department of Economics
1400 Washington Avenue
Albany, NY 12222
United States
518-442 4758 (Phone)
518-442 4736 (Fax)

HOME PAGE: http://www.albany.edu/~klahiri

Liu Yang

Nanjing University - School of Business

22 Hankou Road
Nanjing, Jiangsu 210093 210093
China

State University of New York (SUNY) at Albany, College of Arts and Sciences, Economics ( email )

1400 Washington Ave
Albany, NY 12222
United States
518-442-4735 (Phone)
518-442-4736 (Fax)

HOME PAGE: http://www.albany.edu/economics/

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