NC State

Abstract. We propose a sequential test for predictive ability. The test is designed for regressions in which the researcher is interested in recursively assess-ing whether some economic variables have predictive or explanatory content for another variable. It is common in the forecasting literature to assess predictive ability by using “one-shot ” tests at each estimation period. We show that this practice: (i) leads to size distortions; (ii) selects overfitted models and provides spurious evidence of in-sample predictive ability; (iii) may lower the accuracy of the model selected by the test. The usefulness of the proposed test is shown in well-known empirical applications to the real-time predictive content of money for output, and the selection between linear and non-linear models