Forecast combinations in a DSGE-VAR lab

Abstract

We explore the benefits of forecast combinations based on forecast-encompassing tests compared to simple averages and to Bates–Granger combinations. We also consider a new combination algorithm that fuses test-based and Bates–Granger weighting. For a realistic simulation design, we generate multivariate time series samples from a macroeconomic DSGE-VAR (dynamic stochastic general equilibrium–vector autoregressive) model. Results generally support Bates–Granger over uniform weighting, whereas benefits of test-based weights depend on the sample size and on the prediction horizon. In a corresponding application to real-world data, simple averaging performs best. Uniform averages may be the weighting scheme that is most robust to empirically observed irregularities.