Economic forecasting in a changing world

This article explains the basis for a theory of economic forecasting developed over the past decade by the authors. The research has resulted in numerous articles in academic journals, two monographs, Forecasting Economic Time Series, 1998, Cambridge University Press, and Forecasting Nonstationary Economic Time Series, 1999, MIT Press, and three edited volumes, Understanding Economic Forecasts, 2001, MIT Press, A Companion to Economic Forecasting, 2002, Blackwells, and the Oxford Bulletin of Economics and Statistics, 2005. The aim here is to provide an accessible, non-technical, account of the main ideas. The interested reader is referred to the monographs for derivations, simulation evidence, and further empirical illustrations, which in turn reference the original articles and related material, and provide bibliographic perspective.

Forecasting US output growth using leading indicators: an appraisal using MIDAS models

We evaluate the predictive power of leading indicators for output growth at horizons up to 1 year. We use the MIDAS regression approach as this allows us to combine multiple individual leading indicators in a parsimonious way and to directly exploit the information content of the monthly series to predict quarterly output growth. When we use real-time vintage data, the indicators are found to have significant predictive ability, and this is further enhanced by the use of monthly data on the quarter at the time the forecast is made

Forecasting US output growth with non-linear models in the presence of data uncertainty

We consider the impact of data revisions on the forecast performance of a SETAR regime-switching model of U.S. output growth. The impact of data uncertainty in real-time forecasting will affect a model's forecast performance via the effect on the model parameter estimates as well as via the forecast being conditioned on data measured with error. We find that benchmark revisions do affect the performance of the non-linear model of the growth rate, and that the performance relative to a linear comparator deteriorates in real-time compared to a pseudo out-of-sample forecasting exercise.

Forecasting with vector autoregressive models of data vintages: US output growth and inflation

Vintage-based vector autoregressive models of a single macroeconomic variable are shown to be a useful vehicle for obtaining forecasts of different maturities of future and past observations, including estimates of post-revision values. The forecasting performance of models which include information on annual revisions is superior to that of models which only include the first two data releases. However, the empirical results indicate that a model which reflects the seasonal nature of data releases more closely does not offer much improvement over an unrestricted vintage-based model which includes three rounds of annual revisions.

Real-time forecasting of inflation and output growth with autoregressive models in the presence of data revisions

We examine how the accuracy of real-time forecasts from models that include autoregressive terms can be improved by estimating the models on ‘lightly revised’ data instead of using data from the latest-available vintage. The benefits of estimating autoregressive models on lightly revised data are related to the nature of the data revision process and the underlying process for the true values. Empirically, we find improvements in root mean square forecasting error of 2–4% when forecasting output growth and inflation with univariate models, and of 8% with multivariate models. We show that multiple-vintage models, which explicitly model data revisions, require large estimation samples to deliver competitive forecasts. Copyright © 2012 John Wiley & Sons, Ltd.

The cross-currency hedging performance of implied versus statistical forecasting models

This article examines the ability of several models to generate optimal hedge ratios. Statistical models employed include univariate and multivariate generalized autoregressive conditionally heteroscedastic (GARCH) models, and exponentially weighted and simple moving averages. The variances of the hedged portfolios derived using these hedge ratios are compared with those based on market expectations implied by the prices of traded options. One-month and three-month hedging horizons are considered for four currency pairs. Overall, it has been found that an exponentially weighted moving-average model leads to lower portfolio variances than any of the GARCH-based, implied or time-invariant approaches.

Forecasting real estate returns using financial spreads

This paper examines the predictability of real estate asset returns using a number of time series techniques. A vector autoregressive model, which incorporates financial spreads, is able to improve upon the out of sample forecasting performance of univariate time series models at a short forecasting horizon. However, as the forecasting horizon increases, the explanatory power of such models is reduced, so that returns on real estate assets are best forecast using the long term mean of the series. In the case of indirect property returns, such short-term forecasts can be turned into a trading rule that can generate excess returns over a buy-and-hold strategy gross of transactions costs, although none of the trading rules developed could cover the associated transactions costs. It is therefore concluded that such forecastability is entirely consistent with stock market efficiency.

Forecasting models of retail rents

The authors model retail rents in the United Kingdom with use of vector-autoregressive and time-series models. Two retail rent series are used, compiled by LaSalle Investment Management and CB Hillier Parker, and the emphasis is on forecasting. The results suggest that the use of the vector-autoregression and time-series models in this paper can pick up important features of the data that are useful for forecasting purposes. The relative forecasting performance of the models appears to be subject to the length of the forecast time-horizon. The results also show that the variables which were appropriate for inclusion in the vector-autoregression systems differ between the two rent series, suggesting that the structure of optimal models for predicting retail rents could be specific to the rent index used. Ex ante forecasts from our time-series suggest that both LaSalle Investment Management and CB Hillier Parker real retail rents will exhibit an annual growth rate above their long-term mean.

Bicorrelations and cross-bicorrelations as non-linearity tests and tools for exchange rate forecasting

This paper proposes and implements a new methodology for forecasting time series, based on bicorrelations and cross-bicorrelations. It is shown that the forecasting technique arises as a natural extension of, and as a complement to, existing univariate and multivariate non-linearity tests. The formulations are essentially modified autoregressive or vector autoregressive models respectively, which can be estimated using ordinary least squares. The techniques are applied to a set of high-frequency exchange rate returns, and their out-of-sample forecasting performance is compared to that of other time series models

Forecasting exchange rate volatility using conditional variance models selected by information criteria

This paper uses appropriately modified information criteria to select models from the GARCH family, which are subsequently used for predicting US dollar exchange rate return volatility. The out of sample forecast accuracy of models chosen in this manner compares favourably on mean absolute error grounds, although less favourably on mean squared error grounds, with those generated by the commonly used GARCH(1, 1) model. An examination of the orders of models selected by the criteria reveals that (1, 1) models are typically selected less than 20% of the time.

The potential of 1 h refractivity changes from an operational C-band magnetron-based radar for numerical weather prediction validation and data assimilation

Refractivity changes (ΔN) derived from radar ground clutter returns serve as a proxy for near-surface humidity changes (1 N unit ≡ 1% relative humidity at 20 °C). Previous studies have indicated that better humidity observations should improve forecasts of convection initiation. A preliminary assessment of the potential of refractivity retrievals from an operational magnetron-based C-band radar is presented. The increased phase noise at shorter wavelengths, exacerbated by the unknown position of the target within the 300 m gate, make it difficult to obtain absolute refractivity values, so we consider the information in 1 h changes. These have been derived to a range of 30 km with a spatial resolution of ∼4 km; the consistency of the individual estimates (within each 4 km × 4 km area) indicates that ΔN errors are about 1 N unit, in agreement with in situ observations. Measurements from an instrumented tower on summer days show that the 1 h refractivity changes up to a height of 100 m remain well correlated with near-surface values. The analysis of refractivity as represented in the operational Met Office Unified Model at 1.5, 4 and 12 km grid lengths demonstrates that, as model resolution increases, the spatial scales of the refractivity structures improve. It is shown that the magnitude of refractivity changes is progressively underestimated at larger grid lengths during summer. However, the daily time series of 1 h refractivity changes reveal that, whereas the radar-derived values are very well correlated with the in situ observations, the high-resolution model runs have little skill in getting the right values of ΔN in the right place at the right time. This suggests that the assimilation of these radar refractivity observations could benefit forecasts of the initiation of convection.

Evidence for solar wind modulation of lightning

The response of lightning rates over Europe to arrival of high speed solar wind streams at Earth is investigated using a superposed epoch analysis. Fast solar wind stream arrival is determined from modulation of the solar wind V y component, measured by the Advanced Composition Explorer spacecraft. Lightning rate changes around these event times are determined from the very low frequency arrival time difference (ATD) system of the UK Met Office. Arrival of high speed streams at Earth is found to be preceded by a decrease in total solar irradiance and an increase in sunspot number and Mg II emissions. These are consistent with the high speed stream's source being co-located with an active region appearing on the Eastern solar limb and rotating at the 27 d period of the Sun. Arrival of the high speed stream at Earth also coincides with a small (~1%) but rapid decrease in galactic cosmic ray flux, a moderate (~6%) increase in lower energy solar energetic protons (SEPs), and a substantial, statistically significant increase in lightning rates. These changes persist for around 40 d in all three quantities. The lightning rate increase is corroborated by an increase in the total number of thunder days observed by UK Met stations, again persisting for around 40 d after the arrival of a high speed solar wind stream. This result appears to contradict earlier studies that found an anti-correlation between sunspot number and thunder days over solar cycle timescales. The increase in lightning rates and thunder days that we observe coincides with an increased flux of SEPs which, while not being detected at ground level, nevertheless penetrate the atmosphere to tropospheric altitudes. This effect could be further amplified by an increase in mean lightning stroke intensity that brings more strokes above the detection threshold of the ATD system. In order to remove any potential seasonal bias the analysis was repeated for daily solar wind triggers occurring during the summer months (June to August). Though this reduced the number of solar wind triggers to 32, the response in both lightning and thunder day data remained statistically significant. This modulation of lightning by regular and predictable solar wind events may be beneficial to medium range forecasting of hazardous weather.

The importance of the volatility risk premium for volatility forecasting

In this paper, we study the role of the volatility risk premium for the forecasting performance of implied volatility. We introduce a non-parametric and parsimonious approach to adjust the model-free implied volatility for the volatility risk premium and implement this methodology using more than 20 years of options and futures data on three major energy markets. Using regression models and statistical loss functions, we find compelling evidence to suggest that the risk premium adjusted implied volatility significantly outperforms other models, including its unadjusted counterpart. Our main finding holds for different choices of volatility estimators and competing time-series models, underlying the robustness of our results.