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AN EXAMPLE OF AN OPTIMAL FORECAST EXHIBITING DECREASING BIAS WITH INCREASING FORECAST HORIZON

Authors


  • We are indebted to two anonymous referees for their valuable and insightful comments and suggestions.

Correspondence: Kevin Aretz, Department of Accounting and Finance, Lancaster University, Lancaster LA1 4YX, UK. Tel: +44(0)1524-593 402; Email: k.aretz@lancaster.ac.uk.

ABSTRACT

Motivated by a central banker with an inflation target, we show that the optimal forecast bias under non-quadratic loss functions and non-normal forecast errors can decrease or initially increase and then decrease with the forecast horizon. We initially proof that, if the variable to forecast can be described by a generalized Rayleigh distribution, its conditional mean does in general not constitute the optimal prediction under a symmetric target zone loss function. Subsequently, we approximate the target zone loss function to show the potential for variation in optimal bias over the forecast horizon.

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