Forecasting Time Series Subject to Multiple Structural Breaks

This paper provides a new approach to forecasting time series that are subject to discrete structural breaks. We propose a Bayesian estimation and prediction procedure that allows for the possibility of new breaks occurring over the forecast horizon, taking account of the size and duration of past breaks (if any) by means of a hierarchical hidden Markov chain model. Predictions are formed by integrating over the parameters from the meta-distribution that characterizes the stochastic break-point process. In an application to U.S. Treasury bill rates, we find that the method leads to better out-of-sample forecasts than a range of alternative methods. Copyright 2006 The Review of Economic Studies Limited.