Forecast performance of noncausal autoregressions and the importance of unit root pretesting

Abstract

AbstractBased on a large simulation study, this paper investigates which strategy to adopt in order to choose the most accurate forecasting model for mixed causal‐noncausal autoregressions (MAR) data generating processes: always differencing (D), never differencing (L), or unit root pretesting (P). Relying on recent econometric developments regarding forecasting and unit root testing in the MAR framework, the main results suggest that from a practitioner's point of view, the P strategy at the 10% level is a good compromise. In fact, it never departs too much from the best model in terms of forecast accuracy, unlike the L (respectively, D) strategy when the DGP becomes very persistent (respectively, less persistent). This approach is illustrated using recent monthly Brent crude oil price data.