Detecting and Predicting Forecast Breakdowns

49 Pages Posted: 11 Jul 2006

See all articles by Raffaella Giacomini

Raffaella Giacomini

University College London - Department of Economics; University of California, Los Angeles - Department of Economics

Barbara Rossi

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Barcelona Graduate School of Economics

Date Written: June 2006

Abstract

We propose a theoretical framework for assessing whether a forecast model estimated over one period can provide good forecasts over a subsequent period. We formalize this idea by defining a forecast breakdown as a situation in which the out-of-sample performance of the model, judged by some loss function, is significantly worse than its in-sample performance. Our framework, which is valid under general conditions, can be used not only to detect past forecast breakdowns but also to predict future ones. We show that main causes of forecast breakdowns are instabilities in the data generating process and relate the properties of our forecast breakdown test to those of existing structural break tests. The empirical application finds evidence of a forecast breakdown in the Phillips' curve forecasts of U.S. inflation, and links it to inflation volatility and to changes in the monetary policy reaction function of the Fed.

Keywords: Structural change, Forecast evaluation, Forecast rationality testing, In-sample evaluation, Out-of-sample evaluation

JEL Classification: C22, C52, C53

Suggested Citation

Giacomini, Raffaella and Rossi, Barbara, Detecting and Predicting Forecast Breakdowns (June 2006). ECB Working Paper No. 638, Available at SSRN: https://ssrn.com/abstract=905083 or http://dx.doi.org/10.2139/ssrn.905083

Raffaella Giacomini (Contact Author)

University College London - Department of Economics ( email )

Gower Street
London WC1E 6BT, WC1E 6BT
United Kingdom

University of California, Los Angeles - Department of Economics ( email )

405 Hilgard Avenue
Box 951361
Los Angeles, CA 90095-1361
United States

Barbara Rossi

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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