November 2021

Better the Devil You Know: Improved Forecasts from Imperfect Models

Dong Hwan Oh and Andrew J. Patton

Abstract:

Many important economic decisions are based on a parametric forecasting model that is known to be good but imperfect. We propose methods to improve out-of-sample forecasts from a mis- speci…ed model by estimating its parameters using a form of local M estimation (thereby nesting local OLS and local MLE), drawing on information from a state variable that is correlated with the misspeci…cation of the model. We theoretically consider the forecast environments in which our approach is likely to o¤er improvements over standard methods, and we …nd signi…cant fore- cast improvements from applying the proposed method across distinct empirical analyses including volatility forecasting, risk management, and yield curve forecasting.

DOI: https://doi.org/10.17016/FEDS.2021.071

PDF: Full Paper

Disclaimer: The economic research that is linked from this page represents the views of the authors and does not indicate concurrence either by other members of the Board's staff or by the Board of Governors. The economic research and their conclusions are often preliminary and are circulated to stimulate discussion and critical comment.

The Board values having a staff that conducts research on a wide range of economic topics and that explores a diverse array of perspectives on those topics. The resulting conversations in academia, the economic policy community, and the broader public are important to sharpening our collective thinking.

Back to Top
Last Update: November 05, 2021