The Forecast Combination Puzzle: A Simple Theoretical Explanation

22 Pages Posted: 5 Mar 2016

See all articles by Gerda Claeskens

Gerda Claeskens

KU Leuven - Department of Economics

J.R. Magnus

Vrije Universiteit Amsterdam, School of Business and Economics

Andrey L. Vasnev

University of Sydney

Wendun Wang

Erasmus University Rotterdam (EUR) - Department of Econometrics

Multiple version iconThere are 3 versions of this paper

Date Written: February 2016

Abstract

This paper offers a theoretical explanation for the stylized fact that forecast combinations with estimated optimal weights often perform poorly in applications. The properties of the forecast combination are typically derived under the assumption that the weights are fixed, while in practice they need to be estimated. If the fact that the weights are random rather than fixed is taken into account during the optimality derivation, then the forecast combination will be biased (even when the original forecasts are unbiased) and its variance is larger than in the fixed-weights case. In particular, there is no guarantee that the ‘optimal’ forecast combination will be better than the equal-weights case or even improve on the original forecasts. We provide the underlying theory, some special cases, and a numerical illustration.

Keywords: forecast combination, optimal weights

JEL Classification: C53, C52

Suggested Citation

Claeskens, Gerda and Magnus, Jan R. and Vasnev, Andrey L. and Wang, Wendun, The Forecast Combination Puzzle: A Simple Theoretical Explanation (February 2016). Available at SSRN: https://ssrn.com/abstract=2739690 or http://dx.doi.org/10.2139/ssrn.2739690

Gerda Claeskens (Contact Author)

KU Leuven - Department of Economics ( email )

Leuven, B-3000
Belgium

Jan R. Magnus

Vrije Universiteit Amsterdam, School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Andrey L. Vasnev

University of Sydney ( email )

Sydney, NSW 2006
Australia

HOME PAGE: http://www.econ.usyd.edu.au/staff/andreyv

Wendun Wang

Erasmus University Rotterdam (EUR) - Department of Econometrics ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

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