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    KW Ref 4

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    Evaluating Interval Forecasts Peter F. Christoffersen International Economic Review, Vol. 39, No. 4, Symposium on Forecasting and Empirical Methods in Macroeconomics and Finance (Nov., 1998), 841-862. Stable URL hitp://links jstor-org/sici?sici=0020-6598% 28 1998 11% 2939%3A4%3C841%3AEIF%3E2,0,CO%3B2-W International Economic Review is currently published by Beonomies Department of the University of Pennsylvania, ‘Your use of the ISTOR archive indicates your acceptance of JSTOR’s Terms and Conditions of Use, available at hup:/www,jstororglabout/terms.hml. ISTOR’s Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at hupslwww.jstor.orgijournals/ier_pub.himl. Each copy of any part of @ JSTOR transmission must contain the same copyright notice that appears on the sereen or printed page of such transmission. STOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact jstor-info@ jstor.org, bupswww jstor.org/ ‘Tue Apr 20 05:29:08 2004 INTERNATIONAL ECONOMIC REVIEW ‘Vol 38, No.4, November 1998) EVALUATING INTERVAL FORECASTS* By Prrer F. CHRISTOFFERSEN” McGill University, Canada ‘A complete theory for evaluating interval forecasts has not been worked cut fo date. Most of the literature implicitly assumes homoskedastic errors even when this is clay violated, and proceed by merely esting for correct uncond: tional coverage. Consequently I set out to build @ consistent framework for conditional interval forecast evaluation, which is crucial when higher-order ‘moment dynamics are present. The new methodology is demonsirated in an Application to the exchange rate forecasting procedures advocated i risk ‘management, 1. INrRopucrion ‘The vast majority of research in economic forecasting centers around producing and evaluating point forecasts. Point forecasts are clearly of first-order importance. ‘They are relatively easy to compute, very easy to understand, and they typically ‘guide the immediate action taken by the forecast user. For example, the production manager in a firm wants a forecast of sales in order to decide on production, the chief financial officer wants a forecast of portfolio retums in order to decide on rebalancing, and the central bank governor wants a forecast of inflation in order to carry out monetary policy Quickly the question arises: should the user be content with a point forecast? Quite clearly she should not. By nature, point forecasts are of limited value since they only describe one (albeit important) possible outcome. Interval forecasts are equally important—and often neglected—aids. They indicate the likely range of outcomes, thereby allowing for thorough contingency planning. Thus, the production ‘manager can check the hypothetical inventory holdings under various probable sales conditions, the chief financial officer can assess the effects on the solvency of the firm of a range of possible portfolio returns, and the central bank governor can plan policy actions contingent on likely inflationary developments? + Manuscript received December 195, ' Ema: critopdimanagementmegillea "T would like 10 thank Albert Ando, Anil Bera, Jeremy Berkowitz, Tim Bollerslev, Valentina Corradi, Frank Diebold, Lorenzo Giorgianni, Jin Hahn, Jose Lopez, Roberto Mariano, and two referees for their useful comments. All remaining inadequacies are my own. Special thanks are due 1 Barbara and Eawatd Netter for their generous financial suppor. A survey of actual interval forecasts, provided hy profesional forecasters of macraeconomic time series, can be found in Croushore (1983). sa 842 (CHRISTOFFERSEN Faced with the task of calculating interval predictions, the applied forecaster can build on a large literature, which is summarized in Chatfield (1993). However, when the forecast user wants to evaluate a set of interval forecasts produced by the forecaster, not many tools are available. This paper is intended to address the deficiency by clearly defining what is meant by a ‘good’ interval forecast, and describing how to test if a given interval forecast deserves the label ‘good. One of the motivations of Engle’s (1982) classic paper was to form dynamic interval forecasts around point predictions. The insight was that the intervals should bbe narrow in tranquil times and wide in volatile times, so that the occurrences of ‘observations outside the interval forecast would be spread out over the sample and rot come in clusters. An interval forecast that fails to account for higher-order

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