Berkowitz, Jeremy: Testing the Accuracy of Density Forecasts
World Conference Econometric Society, 2000, Seattle

Jeremy Berkowitz, Federal Reserve Board
Testing the Accuracy of Density Forecasts
Session: C-10-20  Tuesday 15 August 2000  by Berkowitz, Jeremy
The forecast evaluation literature has traditionally focused on methods of assessing point forecasts. However, in the context of many models of financial risk, interest centers on more than just a single point of the forecast distribution. For example, value-at-risk (VaR) models which are currently in extremely wide use form interval forecasts. Many other important financial calculations also involve estimates not summarized by a point forecast. Although some techniques are currently available for assessing interval and density forecasts, existing methods tend to display low power in sample sizes typically available. This paper suggests a new approach to evaluating such forecasts. It requires evaluation of the entire forecast distribution, rather than a scalar or interval. The information content of forecast distributions combined with ex post realizations is enough to construct a powerful test even with sample sizes as small as 100.

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