Chi-squared tests of interval and density forecasts, and the Bank of England’s fan charts.pdfVIP

Chi-squared Tests of Interval and Density Forecasts, and the Bank of England’s Fan Charts Kenneth F. Wallis Department of Economics University of Warwick Coventry CV4 7AL, UK [K.F.Wallis@warwick.ac.uk] Revised August 2001 For presentation at the European Meeting of the Econometric Society, Lausanne, August 2001 Acknowledgement The first version of this paper was written during a period of study leave granted by the University of Warwick and spent at the Economic Research Department, Reserve Bank of Australia and the Economics Program RSSS, Australian National University; the support of these institutions is gratefully acknowledged. Abstract This paper reviews recently proposed likelihood ratio tests of goodness-of-fit and independence of interval forecasts. It recasts them in the framework of Pearson chi-squared statistics, and considers their extension to density forecasts and their exact small-sample distributions. The use of the familiar framework of contingency tables will increase the accessibility of these methods. The tests are applied to two series of density forecasts of inflation, namely the US Survey of Professional Forecasters and the Bank of England fan charts. This first evaluation of the fan chart forecasts finds that whereas the current-quarter forecasts are well-calibrated, this is less true of the one-year-ahead forecasts. The fan charts fan out too quickly, and the excessive concern with the upside