Comparison of forecasting methods with an application to predicting excess equity premium

This paper reviews various forecast methods including combination using theoretically optimal weights and those under model selection approaches. In addition, we suggest two modified simple averaging forecast combination methods - a mean corrected and a mean and scale corrected method. We conclude that due to the fact that real data is usually subject to structural breaks, rolling forecasting scheme has a better performance than fixed window and continuously updating scheme. In addition, methods that use less information appear to perform better than methods using all the sample information about the covariance structure of the available forecasts. The mean and scale corrected simple average approach yield smaller mean squared forecast error than the three widely used regression approaches suggested by Granger and Ramanathan [11].