Optimal Forecast Combination Under Regime Switching
31 Pages Posted: 2 Dec 2004
Date Written: October 2004
This Paper proposes a new forecast combination method that lets the combination weights be driven by regime switching in a latent state variable. An empirical application that combines forecasts from survey data and time series models finds that the proposed regime switching combination scheme performs well for a variety of macroeconomic variables. Monte Carlo simulations shed light on the type of data generating processes for which the proposed combination method can be expected to perform better than a range of alternative combination schemes. Finally, we show how time-variations in the combination weights arise when the target variable and the predictors share a common factor structure driven by a hidden Markov process.
Keywords: Forecast combination, time-varying combination weights, Markov switching, survey data
JEL Classification: C53
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