Ch13: The Risks of Model Based Forecasting: Modeling, Assessing, and Remodeling

Chapter Summary:

Process of developing any forecasting model is basically depends upon three steps:

1. Modeling: build the model upon the basis of economic theory, along with it make the model simple.

2. Assessing: after properly model of economic theory, in terms of econometric language, then check the model accuracy of model. That is how model is predicting the future value. If it is predicting the future values accurately then the model is good and reliable. But if it is not assessing the future value in proper way, then we usually moves to 3^rd step.

3. Remodeling: if the model has not properly assessing power, when we rebuilt the model with different specification. Usually a model is good when it is build, but latter on due to change in economic environment, model lose its reliability and assessing power. That’s why model needs update according to changes in economic environment.

In certain cases, more common in short-term forecasting, due to temporary events, a forecaster would need to incorporate add factors into the model to reduce forecast error. In some cases, remodeling will not be necessary. In long-term forecasting, we suggest producing multiple scenario based forecasts instead of a single forecast. In addition, the nature of break determines whether the forecaster will need to construct a new model.