DP4976 A Comparison of Direct and Iterated Multistep AR Methods for Forecasting Macroeconomic Time Series

Author(s): Massimiliano Marcellino , James H Stock , Mark W Watson

Publication Date: March 2005

Keyword(s): multistep forecasts , VAR forecasts , forecast comparisons

JEL(s): C32 , E37 , E47

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP4976.asp

‘Iterated’ multiperiod ahead time series forecasts are made using a one-period ahead model, iterated forward for the desired number of periods, whereas ‘direct’ forecasts are made using a horizon-specific estimated model, where the dependent variable is the multi-period ahead value being forecasted. Which approach is better is an empirical matter: in theory, iterated forecasts are more efficient if correctly specified, but direct forecasts are more robust to model misspecification. This paper compares empirical iterated and direct forecasts from linear univariate and bivariate models by applying simulated out-of-sample methods to 171 US monthly macroeconomic time series spanning 1959-2002. The iterated forecasts typically outperform the direct forecasts, particularly if the models can select long lag specifications. The relative performance of the iterated forecasts improves with the forecast horizon.