Forecasting in cointegrated systems

Clements, M. P. ORCID: https://orcid.org/0000-0001-6329-1341 and Hendry, D. F. (1995) Forecasting in cointegrated systems. Journal of Applied Econometrics, 10 (2). pp. 127-146. ISSN 1099-1255 doi: 10.1002/jae.3950100204

Abstract/Summary

We consider the implications for forecast accuracy of imposing unit roots and cointegrating restrictions in linear systems of I(1) variables in levels, differences, and cointegrated combinations. Asymptotic formulae are obtained for multi-step forecast error variances for each representation. Alternative measures of forecast accuracy are discussed. Finite sample behaviour in a bivariate model is studied by Monte Carlo using control variables. We also analyse the interaction between unit roots and cointegrating restrictions and intercepts in the DGP. Some of the issues are illustrated with an empirical example of forecasting the demand for M1 in the UK.