Summary of the Paper Entitled ‘The Mean Squared Prediction Error Paradox’
15 Pages Posted: 3 Mar 2021
Date Written: December 29, 2020
This is a summary of the paper entitled: “The Mean Squared Prediction Error Paradox”. In that paper, we show that traditional comparisons of Mean Squared Prediction Error (MSPE) between two competing forecasts may be highly controversial. This is so because when some specific conditions of efficiency are not met, the forecast displaying the lowest MSPE will also display the lowest correlation with the target variable. Given that violations of efficiency are usual in the forecasting literature, this opposite behavior in terms of accuracy and correlation with the target variable may be a fairly common empirical finding that we label here as "the MSPE Paradox." We characterize "Paradox zones" in terms of differences in correlation with the target variable and conduct some simple simulations to show that these zones may be non-empty sets. Finally, we illustrate the relevance of the Paradox with two empirical applications.
Keywords: Mean Squared Prediction Error, Correlation, Forecasting, Time Series, Random Walk.
JEL Classification: C52, C53, G17, E270, E370, F370, L740, O180, R310
Suggested Citation: Suggested Citation