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on Forecasting |
| By: | Massimo Guidolin; Allan Timmerman |
| Abstract: | We propose a four-state multivariate regime switching model to capture common latent factors driving short-term spot and forward rates in the US. For this class of models we develop a flexible approach to combine forecasts of future spot rates with forecasts from alternative sources such as time-series models or models capturing macroeconomic information. We find strong empirical evidence that accounting for both regimes in interest rate dynamics and combining forecasts from different models helps improve the out-of-sample forecasting performance for short-term interest rates in the US. Theoretical restrictions from the expectations hypothesis when imposed on the forecasting model are found to help only at long forecasting horizons. |
| Keywords: | Interest rates ; Forecasting |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2005-059&r=for |
| By: | Ali Dib; Mohamed Gammoudi; Kevin Moran |
| Abstract: | This paper documents the out-of-sample forecasting accuracy of the New Keynesian Model for Canada. We repeatedly estimate our variant of the model on a series of rolling subsamples, forecasting out-of-sample one to eight quarters ahead at each step. We then compare these forecasts to those arising from simple VARs, using econometric tests of forecasting accuracy. Our results show that the forecasting accuracy of the New Keynesian model compares favourably to that of the benchmarks, particularly as the forecasting horizon increases. These results suggest that the model can become a useful forecasting tool for Canadian time series. The principle of parsimony is invoked to explain our findings. |
| Keywords: | New Keynesian Model, Forecasting accuracy |
| JEL: | C53 E37 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:0527&r=for |
| By: | Sascha Mergner (AMB Generali Asset Managers) |
| Abstract: | This paper investigates the time-varying behavior of systematic risk for eighteen pan-European industry portfolios. Using weekly data over the period 1987-2005, three different modeling techniques in addition to the standard constant coefficient model are employed: a bivariate t- GARCH(1,1) model, two Kalman filter based approaches as well as a bivariate stochastic volatility model estimated via the efficient Monte Carlo likelihood technique. A comparison of the different models' ex- ante forecast performances indicates that the random-walk process in connection with the Kalman filter is the preferred model to describe and forecast the time-varying behavior of sector betas in a European context. |
| Keywords: | Time-varying beta risk; Kalman filter; bivariate t-GARCH; stochastic volatility; efficient Monte Carlo likelihood; European industry portfolios |
| JEL: | C22 C32 G10 G12 G15 |
| Date: | 2005–09–21 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpfi:0509024&r=for |
| By: | Philippe Bacchetta; Eric van Wincoop |
| Abstract: | The uncovered interest rate parity equation is the cornerstone of most models in international macro. However, this equation does not hold empirically since the forward discount, or interest rate differential, is negatively related to the subsequent change in the exchange rate. This forward discount puzzle is one of the most extensively researched areas in international finance. It implies that excess returns on foreign currency investments are predictable. In this paper we propose a new explanation for this puzzle based on rational inattention. We develop a model where investors face a cost of collecting and processing information. Investors with low information processing costs trade actively, while other investors are inattentive and trade infrequently. We calibrate the model to the data and show that (i) inattention can account for most of the observed predictability of excess returns in the foreign exchange market, (ii) the benefit from frequent trading is relatively small so that few investors choose to be attentive, (iii) average expectational errors about future exchange rates are predictable in a way consistent with survey data for market participants, and (iv) the model can account for the puzzle of delayed overshooting of the exchange rate in response to interest rate shocks. |
| JEL: | F3 G1 E4 |
| Date: | 2005–09 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:11633&r=for |
| By: | Francis Vitek (University of British Columbia) |
| Abstract: | We survey and update the empirical literature concerning the predictability of nominal exchange rates using structural macroeconomic models over the recent floating exchange rate period. In particular, we consider both flexible and sticky price versions of the monetary model of nominal exchange rate determination. In agreement with the existing empirical literature, we find that nominal exchange rate movements are difficult to forecast, with a random walk generally dominating the monetary model in terms of predictive accuracy conditional on observed monetary fundamentals at all horizons. |
| Keywords: | Exchange rate forecasting; Monetary model |
| JEL: | F31 |
| Date: | 2005–09–14 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpif:0509005&r=for |
| By: | Peter Tulip |
| Abstract: | Several researchers have recently documented a large reduction in output volatility. In contrast, this paper examines whether output has become more predictable. Using forecasts from the Federal Reserve Greenbooks, I find the evidence is somewhat mixed. Output seems to have become more predictable at short horizons, but not necessarily at longer horizons. The reduction in unpredictability is much less than the reduction in volatility. Associated with this, recent forecasts had little predictive power. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2005-31&r=for |
| By: | Giannone, Domenico; Reichlin, Lucrezia; Small, David |
| Abstract: | This paper formalizes the process of updating the nowcast and forecast on output and inflation as new releases of data become available. The marginal contribution of a particular release for the value of the signal and its precision is evaluated by computing 'news' on the basis of an evolving conditioning information set. The marginal contribution is then split into what is due to timeliness of information and what is due to economic content. We find that the Federal Reserve Bank of Philadelphia surveys have a large marginal impact on the nowcast of both inflation variables and real variables and this effect is larger than that of the Employment Report. When we control for timeliness of the releases, the effect of hard data becomes sizeable. Prices and quantities affect the precision of the estimates of GDP while inflation is only affected by nominal variables and asset prices. |
| Keywords: | factor model; forecasting; large datasets; monetary policy; news; real time data |
| JEL: | C33 C53 E52 |
| Date: | 2005–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5178&r=for |
| By: | Todd B. Walker (University of Iowa) |
| Abstract: | Accommodating asymmetric information in a dynamic asset pricing model is technically challenging due to the problems associated with higher-order expectations. That is, rational investors are forced into a situation where they must forecast the forecasts of other agents (i.e., form higher-order expectations). In a dynamic setting, this problem telescopes into the infinite future and the dimension of the relevant state space approaches infinity. By employing the frequency domain approach of Whiteman (1983) and Kasa (2000), this paper demonstrates how information structures previously believed to lead to disparate expectations in equilibrium (e.g., Singleton (1987)) converge to a symmetric equilibrium. The “revealing” aspect of the price process lies in the invertibility of the observed state space, which makes it possible for agents to infer the economically fundamental shocks, thus eliminating the need to forecast the forecasts of others. |
| Keywords: | Asymmetric Information, Asset Pricing, Frequency Domain |
| JEL: | G |
| Date: | 2005–09–18 |
| URL: | http://d.repec.org/n?u=RePEc:wpa:wuwpfi:0509021&r=for |
| By: | Bjørn-Roger Wilhelmsen (Norges Bank); Andrea Zaghini (Banca d’Italia) |
| Abstract: | The paper evaluates the ability of market participants to anticipate monetary policy decisions in the euro area and in 13 other countries. First, by looking at the magnitude and the volatility of the changes in the money market rates we show that the days of policy meetings are special days for financial markets. Second, we find that the predictability of the ECB’s monetary policy is fully comparable (and sometimes slightly better) to that of the FED and the Bank of England. Finally, an econometric analysis of the ability of market participants to incorporate in the current money rates the expected changes in the key policy rate shows that in the euro area policy decisions are anticipated well in advance. |
| Keywords: | Monetary policy, Predictability, Money market rates |
| JEL: | E4 E5 G1 |
| Date: | 2005–09–02 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2005_07&r=for |
| By: | Braverman, Oded; Kandel, Shmuel; Wohl, Avi |
| Abstract: | This paper provides a new look at the timing of mutual fund investors. We re-examine the relationship between investors' aggregate net flows into and out of the funds and the returns of the funds in subsequent periods. The negative relationship that we find (using monthly data of aggregate US equity mutual funds in the years 1984-2003 and a statistical test based on bootstrapping of returns) causes mutual fund investors, as a group, to realize a lower long-term accumulated return than the long-term accumulated return on a 'buy and hold' position in these funds. The 'bad' performance of mutual fund investors can be explained either by 'behavioural explanations' such as investor sentiment or by 'rational market explanations' that are based on time-varying risk premiums. We present a simple overlapping-generation model which predicts a negative relationship between flows and subsequent returns. It is assumed that flows into and out of funds are not related to information about future cash flows (dividends), but are caused by changes in other factors affecting the demand for stocks. Hence, a positive (negative) net flow in a given month implies a positive (negative) price change in the same month, but also lower (higher) expected future returns. We show that in each month the change in the expected future returns may be small (relative to the return variance), but the accumulated effect of these changes may be significant. This result may explain why previous studies, using monthly data of flows and returns in either simple regression models or VAR, could not have significantly detected the monthly change in the expected future returns even in a 15-year sample. |
| Keywords: | market timing; mutual funds; time-varying expected returns |
| JEL: | G1 G11 G12 |
| Date: | 2005–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:5243&r=for |
| By: | Hart, J. van der; Zwart, G. de; Dijk, D.J.C. van (Erasmus Research Institute of Management (ERIM), RSM Erasmus University) |
| Abstract: | We examine competing explanations, based on risk and behavioral models, for the profitability of stock selection strategies in emerging markets. We document that both emerging market risk and global risk factors cannot account for the significant excess returns of selection strategies based on value, momentum and earnings revisions indicators. The findings for value and momentum strategies are consistent with the evidence from developed markets supporting behavioral explanations. In addition, for value stocks, the most important behavioral bias appears to be related to underestimation of long-term growth prospects, as indicated by overly pessimistic analysts' earnings forecasts and above average earnings revisions for longer postformation horizons and by quite rapidly improving earnings growth expectations. Furthermore, we find that overreaction effects play a limited role for the earnings revisions strategy, as there is no clear return reversal up until five years after portfolio formation, setting this strategy apart from momentum strategies. |
| Keywords: | value;momentum;earnings revisions;risk;behavioral models;overreaction;underreaction; |
| Date: | 2005–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:eureri:30002101&r=for |
| By: | Hui Guo; Robert Savickas |
| Abstract: | We find that the value-weighted idiosyncratic stock volatility and aggregate stock market volatility jointly exhibit strong predictive power for excess stock market returns. The stock market risk-return relation is found to be positive, as stipulated by the CAPM; however, idiosyncratic volatility is negatively related to future stock market returns. Also, idiosyncratic volatility appears to be a pervasive macrovariable, and its forecasting abilities are very similar to those of the consumption-wealth ratio proposed by Lettau and Ludvigson (2001). |
| Keywords: | Stock market ; Assets (Accounting) - Prices |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2003-028&r=for |
| By: | Ekaterini Panopoulou (Department of Banking and Financial Management, University of Piraeus, Greece and Department of Economics, National University of Ireland Maynooth.); B. Groom (Department of Economics, University College London.); P. Koundouri (Department of Economics, University of Reading, UK and Department of Economics, University College London, UK.); Theologos Pantelidis (Department of Banking and Financial Management, University of Piraeus, Greece.) |
| Abstract: | Evaluating investments with long-term consequences using discount rates that decline with the time horizon, (Declining Discount Rates or DDRs) means that future welfare changes are of greater consequence in present value terms. Recent work in this area has turned towards operationalising the theory and establishing a schedule of DDRs for use in cost benefit analysis. Using US data we make the following points concerning this transition: i) model selection has important implications for operationalising a theory of DDRs that depends upon uncertainty; ii) misspecification testing naturally leads to employing models that account for changes in the interest rate generating mechanism. Lastly, we provide an analysis of the policy implications of DDRs in the context of climate change for the US and show that the use of a state space model can increase valuations by 150% compared to conventional constant discounting. |
| Keywords: | long-run discounting, interest rate forecasting,interest rate forecasting, state-space models,regime-switching models, climate change policy |
| JEL: | C13 C53 Q2 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:may:mayecw:n1480105&r=for |
| By: | M. VANHOUCKE; S. VANDEVOORDE |
| Abstract: | It is well-known that well managed and controlled projects are more likely to be delivered on time and within budget. The construction of a (resource-feasible) baseline schedule and the follow-up during execution are primary contributors to the success or failure of a project. Earned value management systems have been set up to deal with the complex task of controlling and adjusting the baseline project schedule during execution. Although earned value systems have been proven to provide reliable estimates for the follow-up of cost performance, it often fails to predict the total duration of the project. In this paper, we extensively review the existing methods to forecast the total project duration. Moreover, we investigate the potential of a newly developed method, the earned schedule method, which makes the connection between earned value metrics and the project schedule. We present an extensive simulation study where we carefully control the level of uncertainty in the project, the influence of the project network structure on the accuracy of the forecasts, and the time horizon where the newly developed measures provide accurate and reliable results. |
| Keywords: | Earned value; earned duration; earned schedule; CPM |
| Date: | 2005–07 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:05/317&r=for |
| By: | Lars E.O. Svensson; Robert J. Tetlow |
| Abstract: | We outline a method to provide advice on optimal monetary policy while taking policymakers' judgment into account. The method constructs optimal policy projections (OPPs) by extracting the judgment terms that allow a model, such as the Federal Reserve Board staff economic model, FRB/US, to reproduce a forecast, such as the Greenbook forecast. Given an intertemporal loss function that represents monetary policy objectives, OPPs are the projections---of target variables, instruments, and other variables of interest---that minimize that loss function for given judgment terms. The method is illustrated by revisiting the economy of early 1997 as seen in the Greenbook forecasts of February 1997 and November 1999. In both cases, we use the vintage of the FRB/US model that was in place at that time. These two particular forecasts were chosen, in part, because they were at the beginning and the peak, respectively, of the late 1990s boom period. As such, they differ markedly in their implied judgments of the state of the world in 1997 and our OPPs illustrate this difference. For a conventional loss function, our OPPs provide significantly better performance than Taylor-rule simulations. |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2005-34&r=for |
| By: | James Bullard (Federal Reserve Bank of St. Louis); George W. Evans (University of Oregon Economics Department); Seppo Honkapohja (University of Cambridge) |
| Abstract: | We study how the use of judgement or "add-factors" in macroeconomic forecasting may disturb the set of equilibrium outcomes when agents learn using recursive methods. We isolate conditions under which new phenomena, which we call exuberance equilibria, can exist in standard macroeconomic environments. Examples include a simple asset pricing model and the New Keynesian monetary policy framework. Inclusion of judgement in forecasts can lead to self-fulfilling fluctuations, but without the requirement that the underlying rational expectations equilibrium is locally indeterminate. We suggest ways in which policymakers might avoid unintended outcomes by adjusting policy to minimize the risk of exuberance equilibria. |
| Keywords: | Learning, expectations, excess volatility, bounded rationality, monetary policy |
| JEL: | E52 E61 |
| Date: | 2005–09–17 |
| URL: | http://d.repec.org/n?u=RePEc:ore:uoecwp:2005-15&r=for |
| By: | G. LANINE; R. VANDER VENNET |
| Abstract: | The Russian banking sector experienced considerable turmoil in the late 1990s, especially around the Russian banking crisis in 1998. The question is what types of banks are vulnerable to shocks and whether or not bank-specific characteristics can be used to predict vulnerability to failures. In this study we employ a parametric logit model and a nonparametric trait recognition approach to predict failures among Russian commercial banks. We test the predictive power of both models based on their prediction accuracy using holdout samples. Both models performed better than the benchmark; the trait recognition approach outperformed logit in both the original and the holdout samples. As expected liquidity plays an important role in bank failure prediction, but also asset quality and capital adequacy turn out to be important determinants of failure. |
| Keywords: | Russian banks, bank failure prediction, logit model, trait recognition, forecasting accuracy |
| JEL: | C25 G21 G33 |
| Date: | 2005–08 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:05/329&r=for |
| By: | Massimo Guidolin; Sadayuki Ono |
| Abstract: | We estimate a number of multivariate regime switching VAR models on a long monthly data set for eight variables that include excess stock and bond returns, the real T-bill yield, predictors used in the finance literature (default spread and the dividend yield), and three macroeconomic variables (inflation, real industrial production growth, and a measure of real money growth). Heteroskedasticity may be accounted for by making the covariance matrix a function of the regime. We find evidence of four regimes and of time-varying covariances. We provide evidence that the best in-sample fit is provided by a four state model in which the VAR(1) component fails to be regime-dependent. We interpret this as evidence that the dynamic linkages between financial markets and the macroeconomy have been stable over time. We show that the four-state model can be helpful in forecasting applications and to provide one-step ahead predicted Sharpe ratios. |
| Keywords: | Macroeconomics ; Assets (Accounting) - Prices |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2005-056&r=for |