Is there an optimal forecast combination? A stochastic dominance approach to forecast combination puzzle

Mehmet Pinar, T Stengos, E Yazgan

Research output: Contribution to conferenceLecture

Abstract

Even though different optimal forecast combination weights are offered for static, dynamic, or time-varying situations, empirical findings support the simple average forecast combination outperforms more sophisticated weighting schemes and/or the best individual model. Using an approach that relies on consistent tests for stochastic dominance efficiency, an alternative optimal weighting scheme is proposed. These tests are considered for a given forecast combination (i.e. equal weighted average of forecasts) with respect to all possible forecast combinations constructed from a set of individual forecasts to obtain optimal or worst forecast combinations. In our empirical applications we find that equally weighted forecast combinations are neither optimal nor the worst forecast combination. For the optimal forecast combination, the best forecasting model, i.e. the model which assumes relatively more weight than other forecast models, differs with the variable being forecasted and for different forecast horizons. On the other hand, random walk is the model that consistently contributes with more than arbitrarily assigned equal weights for the worst forecast combination for all variables being forecasted and for all forecast horizons.
Original languageEnglish
Publication statusPublished - 2012
EventSociety for Nonlinear Dynamics and Econometrics 20th Annual Symposium - Istanbul Bilgi University, Istanbul, Turkey
Duration: 5 Apr 20126 Apr 2012

Conference

ConferenceSociety for Nonlinear Dynamics and Econometrics 20th Annual Symposium
CountryTurkey
CityIstanbul
Period5/04/126/04/12

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