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Seoul Journal of Economics
[ Article ]
Seoul Journal of Economics - Vol. 16, No. 3, pp.363-386
ISSN: 1225-0279 (Print)
Print publication date 31 Aug 2003
Received 19 Feb 2003 Revised 07 Apr 2004

Relationship of Forecast Encompassing to Composite Forecasts with Simulations and an Application

Kuo-yuan Liang ; Keunkwan Ryu
President, Polaris Research Institute, 1F, No. 339, SinHu 2nd Road, NeiHu, 114, Taipei, Taiwan, Tel: +886-2-8791-8899, Fax: +886-2-2790-6594 kyliang@polaris.com.tw
Associate Professor, School of Economics, Seoul National University, San 56-1, Sillim-dong, Kwanak-gu, Seoul 151-742, Korea, Tel: +82-2-880-6397, Fax: +82-2-886-4231 ryu@snu.ac.kr

JEL Classification: C52, C53, C12, C15

Abstract

This paper examines the role of forecast-encompassing principles in model-specification searches through the use of linear composite forecasts. Based on the results of the pairwise forecast-encompassing test, this paper outlines a conceptual framework to provide some useful insights on cross-model evaluations in econometrics and the selection of predictors in composite forecasts. Second, it offers three different ways of performing the encompassing test and compares their finite sample performance through a Monte Carlo simulation study. Test results guide researchers to choose component forecasts and thus to avoid blind pooling in the combining regression.

Keywords:

Choice of forecasts, Composite forecasts, Forecast-encompassing test, Monte-Carlo simulation, Nonnested hypotheses

Acknowledgments

The authors would like to thank anonymous referees for helpful comments, and the corresponding author would like to thank the Korea Research Foundation for financial assistance through BK21 funding.

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