An Empirical Investigation of Direct and Iterated Multistep Conditional Forecasts

38 Pages Posted: 28 Nov 2017

See all articles by Michael W. McCracken

Michael W. McCracken

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Joseph McGillicuddy

Federal Reserve Banks - Federal Reserve Bank of St. Louis

Date Written: 2017-11-01

Abstract

When constructing unconditional point forecasts, both direct- and iterated-multistep (DMS and IMS) approaches are common. However, in the context of producing conditional forecasts, IMS approaches based on vector autoregressions (VAR) are far more common than simpler DMS models. This is despite the fact that there are theoretical reasons to believe that DMS models are more robust to misspecification than are IMS models. In the context of unconditional forecasts, Marcellino, Stock, and Watson (MSW, 2006) investigate the empirical relevance of these theories. In this paper, we extend that work to conditional forecasts. We do so based on linear bivariate and trivariate models estimated using a large dataset of macroeconomic time series. Over comparable samples, our results reinforce those in MSW: the IMS approach is typically a bit better than DMS with significant improvements only at longer horizons. In contrast, when we focus on the Great Moderation sample we find a marked improvement in the DMS approach relative to IMS. The distinction is particularly clear when we forecast nominal rather than real variables where the relative gains can be substantial.

Keywords: Prediction, forecasting, out-of-sample

JEL Classification: C12, C32, C52, C53

Suggested Citation

McCracken, Michael W. and McGillicuddy, Joseph, An Empirical Investigation of Direct and Iterated Multistep Conditional Forecasts (2017-11-01). FRB St. Louis Working Paper No. 2017-40, Available at SSRN: https://ssrn.com/abstract=3078600 or http://dx.doi.org/10.20955/wp.2017.040

Michael W. McCracken (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of St. Louis ( email )

411 Locust St
Saint Louis, MO 63011
United States

Joseph McGillicuddy

Federal Reserve Banks - Federal Reserve Bank of St. Louis

411 Locust St
Saint Louis, MO 63011
United States

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