Evaluating the Bank of England density forecasts of inflation

We consider evaluating the UK Monetary Policy Committee's inflation density forecasts using probability integral transform goodness-of-fit tests. These tests evaluate the whole forecast density. We also consider whether the probabilities assigned to inflation being in certain ranges are well calibrated, where the ranges are chosen to be those of particular relevance to the MPC, given its remit of maintaining inflation rates in a band around per annum. Finally, we discuss the decision-based approach to forecast evaluation in relation to the MPC forecasts

Evaluating the Survey of Professional Forecasters probability distributions of expected inflation based on derived event probability forecasts

Techniques are proposed for evaluating forecast probabilities of events. The tools are especially useful when, as in the case of the Survey of Professional Forecasters (SPF) expected probability distributions of inflation, recourse cannot be made to the method of construction in the evaluation of the forecasts. The tests of efficiency and conditional efficiency are applied to the forecast probabilities of events of interest derived from the SPF distributions, and supplement a whole-density evaluation of the SPF distributions based on the probability integral transform approach.

Quantile forecasts of daily exchange rate returns from forecasts of realized volatility

Quantile forecasts are central to risk management decisions because of the widespread use of Value-at-Risk. A quantile forecast is the product of two factors: the model used to forecast volatility, and the method of computing quantiles from the volatility forecasts. In this paper we calculate and evaluate quantile forecasts of the daily exchange rate returns of five currencies. The forecasting models that have been used in recent analyses of the predictability of daily realized volatility permit a comparison of the predictive power of different measures of intraday variation and intraday returns in forecasting exchange rate variability. The methods of computing quantile forecasts include making distributional assumptions for future daily returns as well as using the empirical distribution of predicted standardized returns with both rolling and recursive samples. Our main findings are that the Heterogenous Autoregressive model provides more accurate volatility and quantile forecasts for currencies which experience shifts in volatility, such as the Canadian dollar, and that the use of the empirical distribution to calculate quantiles can improve forecasts when there are shifts

Explanations of the inconsistencies in survey respondents' forecasts

A comparison of the point forecasts and the probability distributions of inflation and output growth made by individual respondents to the US Survey of Professional Forecasters indicates that the two sets of forecasts are sometimes inconsistent. We evaluate a number of possible explanations, and find that not all forecasters update their histogram forecasts as new information arrives. This is supported by the finding that the point forecasts are more accurate than the histograms in terms of first-moment prediction.

Combining probability forecasts

We consider different methods for combining probability forecasts. In empirical exercises, the data generating process of the forecasts and the event being forecast is not known, and therefore the optimal form of combination will also be unknown. We consider the properties of various combination schemes for a number of plausible data generating processes, and indicate which types of combinations are likely to be useful. We also show that whether forecast encompassing is found to hold between two rival sets of forecasts or not may depend on the type of combination adopted. The relative performances of the different combination methods are illustrated, with an application to predicting recession probabilities using leading indicators.

Probability distributions or point predictions? Survey forecasts of US output growth and inflation

We consider whether survey respondents’ probability distributions, reported as histograms, provide reliable and coherent point predictions, when viewed through the lens of a Bayesian learning model. We argue that a role remains for eliciting directly-reported point predictions in surveys of professional forecasters.

Examining reliability of seasonal to decadal sea surface temperature forecasts: the role of ensemble dispersion

Useful probabilistic climate forecasts on decadal timescales should be reliable (i.e. forecast probabilities match the observed relative frequencies) but this is seldom examined. This paper assesses a necessary condition for reliability, that the ratio of ensemble spread to forecast error being close to one, for seasonal to decadal sea surface temperature retrospective forecasts from the Met Office Decadal Prediction System (DePreSys). Factors which may affect reliability are diagnosed by comparing this spread-error ratio for an initial condition ensemble and two perturbed physics ensembles for initialized and uninitialized predictions. At lead times less than 2 years, the initialized ensembles tend to be under-dispersed, and hence produce overconfident and hence unreliable forecasts. For longer lead times, all three ensembles are predominantly over-dispersed. Such over-dispersion is primarily related to excessive inter-annual variability in the climate model. These findings highlight the need to carefully evaluate simulated variability in seasonal and decadal prediction systems.Useful probabilistic climate forecasts on decadal timescales should be reliable (i.e. forecast probabilities match the observed relative frequencies) but this is seldom examined. This paper assesses a necessary condition for reliability, that the ratio of ensemble spread to forecast error being close to one, for seasonal to decadal sea surface temperature retrospective forecasts from the Met Office Decadal Prediction System (DePreSys). Factors which may affect reliability are diagnosed by comparing this spread-error ratio for an initial condition ensemble and two perturbed physics ensembles for initialized and uninitialized predictions. At lead times less than 2 years, the initialized ensembles tend to be under-dispersed, and hence produce overconfident and hence unreliable forecasts. For longer lead times, all three ensembles are predominantly over-dispersed. Such over-dispersion is primarily related to excessive inter-annual variability in the climate model. These findings highlight the need to carefully evaluate simulated variability in seasonal and decadal prediction systems.

The trading profitability of forecasts of the gilt–equity yield ratio

Research has highlighted the usefulness of the Gilt–Equity Yield Ratio (GEYR) as a predictor of UK stock returns. This paper extends recent studies by endogenising the threshold at which the GEYR switches from being low to being high or vice versa, thus improving the arbitrary nature of the determination of the threshold employed in the extant literature. It is observed that a decision rule for investing in equities or bonds, based on the forecasts from a regime switching model, yields higher average returns with lower variability than a static portfolio containing any combinations of equities and bonds. A closer inspection of the results reveals that the model has power to forecast when investors should steer clear of equities, although the trading profits generated are insufficient to outweigh the associated transaction costs.

A comparative analysis of the accuracy and uncertainty in real estate and macroeconomic forecasts

We compare and contrast the accuracy and uncertainty in forecasts of rents with those for a variety of macroeconomic series. The results show that in general forecasters tend to be marginally more accurate in the case of macro-economic series than with rents. In common across all of the series, forecasts tend to be smoothed with forecasters under-estimating performance during economic booms, and vice-versa in recessions We find that property forecasts are affected by economic uncertainty, as measured by disagreement across the macro-forecasters. Increased uncertainty leads to increased dispersion in the rental forecasts and a reduction in forecast accuracy.

Rationality and momentum in real estate investment forecasts

This study examines the rationality and momentum in forecasts for rental, capital value and total returns for the real estate investment market in the United Kingdom. In order to investigate if forecasters are affected by the general economic conditions present at the time of forecast we incorporate into the analysis Gross Domestic Product(GDP) and the Default Spread (DS). The empirical findings show high levels of momentum in the forecasts, with highly persistent forecast errors. The results also indicate that forecasters are affected by adverse conditions. This is consistent with the finding that they tend to exhibit greater forecast error when the property market is underperforming and vice-versa.

Predictability of the western North Pacific summer climate associated with different ENSO phases by ENSEMBLES multi-model seasonal forecasts

Predictability of the western North Pacific (WNP) summer climate associated with different El Niño–Southern Oscillation (ENSO) phases is investigated in this study based on the 1-month lead retrospective forecasts of five state-of-the-art coupled models from ENSEMBLES. During the period from 1960 to 2005, the models well capture the WNP summer climate anomalies during most of years in different ENSO phases except the La Niña decaying summers. In the El Niño developing, El Niño decaying and La Niña developing summers, the prediction skills are high for the WNP summer monsoon index (WNPMI), with the prediction correlation larger than 0.7. The high prediction skills of the lower-tropospheric circulation during these phases are found mainly over the tropical western Pacific Ocean, South China Sea and subtropical WNP. These good predictions correspond well to their close teleconnection with ENSO and the high prediction skills of tropical SSTs. By contrast, for the La Niña decaying summers, the prediction skills are considerably low with the prediction correlation for the WNPMI near to zero and low prediction skills around the Philippines and subtropical WNP. These poor predictions relate to the weak summer anomalies of the WNPMI during the La Niña decaying years and no significant connections between the WNP lower-tropospheric circulation anomalies and the SSTs over the tropical central and eastern Pacific Ocean in observations. However, the models tend to predict an apparent anomalous cyclone over the WNP during the La Niña decaying years, indicating a linearity of the circulation response over WNP in the models prediction in comparison with that during the El Niño decaying years which differs from observations. In addition, the models show considerable capability in describing the WNP summer anomalies during the ENSO neutral summers. These anomalies are related to the positive feedback between the WNP lower-tropospheric circulation and the local SSTs. The models can capture this positive feedback but with some uncertainties from different ensemble members during the ENSO neutral summers.

Verification of European subseasonal wind speed forecasts

Analysis of the forecasts and hindcasts from the ECMWF 32-day forecast model reveals that there is statistically significant skill in predicting weekly mean wind speeds over areas of Europe at lead times of at least 14–20 days. Previous research on wind speed predictability has focused on the short- to medium-range time scales, typically finding that forecasts lose all skill by the later part of the medium-range forecast. To the authors’ knowledge, this research is the first to look beyond the medium-range time scale by taking weekly mean wind speeds, instead of averages at hourly or daily resolution, for the ECMWF monthly forecasting system. It is shown that the operational forecasts have high levels of correlation (~0.6) between the forecasts and observations over the winters of 2008–12 for some areas of Europe. Hindcasts covering 20 winters show a more modest level of correlation but are still skillful. Additional analysis examines the probabilistic skill for the United Kingdom with the application of wind power forecasting in mind. It is also shown that there is forecast “value” for end users (operating in a simple cost/loss ratio decision-making framework). End users that are sensitive to winter wind speed variability over the United Kingdom, Germany, and some other areas of Europe should therefore consider forecasts beyond the medium-range time scale as it is clear there is useful information contained within the forecast.

Review: the predictability of the extra-tropical stratosphere on monthly timescales and its impact on the skill of tropospheric forecasts

Extreme variability of the winter- and spring-time stratospheric polar vortex has been shown to affect extratropical tropospheric weather. Therefore, reducing stratospheric forecast error may be one way to improve the skill of tropospheric weather forecasts. In this review, the basis for this idea is examined. A range of studies of different stratospheric extreme vortex events shows that they can be skilfully forecasted beyond five days and into the sub-seasonal range (0-30 days) in some cases. Separate studies show that typical errors in forecasting a stratospheric extreme vortex event can alter tropospheric forecasts skill by 5-7% in the extratropics on sub-seasonal timescales. Thus understanding what limits stratospheric predictability is of significant interest to operational forecasting centres. Both limitations in forecasting tropospheric planetary waves and stratospheric model biases have been shown to be important in this context.

Improving flood forecasts for better flood preparedness in the UK (and beyond)

This winter (2013/14) coastal storms and an unprecedented amount of rainfall led to significant and widespread flooding across the southern UK. Despite much criticism and blame surrounding the flood events, the Flood Forecasting Centre, a recent development in national-level flood forecasting capabilities for the government and emergency response communities, has received considerable praise. Here we consider how scientific developments and organisational change have led to improvements in the forecasting and flood preparedness seen in this winter's flooding. Although such improvements are admirable, there are many technical and communication challenges that remain for probabilistic flood forecasts to achieve their full potential.