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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2014/12:
A Likelihood Ratio and Markov Chain Based Method to Evaluate Density Forecasting

Yushu Li () and Jonas Andersson ()

Abstract: In this paper, we propose a likelihood ratio and Markov chain based method to evaluate density forecasting. This method can jointly evaluate the unconditional forecasted distribution and dependence of the outcomes. This method is an extension of the widely applied evaluation method for interval forecasting proposed by Christoffersen (1998). It is also a more refined approach than the pure contingency table based density forecasting method in Wallis (2003). We show that our method has very high power against incorrect forecasting distributions and dependence. Moreover, the straightforwardness and ease of application of this joint test provide a high potentiality for further applications in both financial and economical areas.

Keywords: Likelihood ratio test; Markov Chain; Density forecasting; (follow links to similar papers)

JEL-Codes: C14; C53; C61; (follow links to similar papers)

12 pages, March 25, 2014

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