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.
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‘Tue Apr 20 05:29:08 2004INTERNATIONAL 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).
sa842 (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