Variable Selection and Forecasting in High Dimensional Linear Regressions with Structural Breaks

Working Paper Revision: Variable Selection in High Dimensional Linear Regressions with Parameter Instability
Working Paper Revision: Variable Selection and Forecasting in High Dimensional Linear Regressions with Structural Breaks

Chudik, Alexander; Pesaran, M. Hashem; Sharifvaghefi, Mahrad

doi:10.24149/gwp394

Working Paper

Variable Selection and Forecasting in High Dimensional Linear Regressions with Structural Breaks

Abstract: This paper is concerned with the problem of variable selection and forecasting in the presence of parameter instability. There are a number of approaches proposed for forecasting in the presence of breaks, including the use of rolling windows or exponential down-weighting. However, these studies start with a given model specification and do not consider the problem of variable selection. It is clear that, in the absence of breaks, researchers should weigh the observations equally at both the variable selection and forecasting stages. In this study, we investigate whether or not we should use weighted observations at the variable selection stage in the presence of structural breaks, particularly when the number of potential covariates is large. Amongst the extant variable selection approaches we focus on the recently developed One Covariate at a time Multiple Testing (OCMT) method that allows a natural distinction between the selection and forecasting stages, and provide theoretical justification for using the full (not down-weighted) sample in the selection stage of OCMT and down-weighting of observations only at the forecasting stage (if needed). The benefits of the proposed method are illustrated by empirical applications to forecasting output growths and stock market returns.

Keywords: Time-varying parameters; structural breaks; high-dimensionality; multiple testing; variable selection; one covariate at a time multiple testing (OCMT); forecasting;

JEL Classification: C22; C52; C53; C55;

https://doi.org/10.24149/gwp394