Forecast Combination when Outcomes are Di¢ cult to Predict

We show that when outcomes are di¢ cult to forecast in the sense that forecast errors have a large common component that (a) optimal weights are not a¤ected by this common component, and may well be far from equal to each other but (b) the relative MSE loss from averaging over optimal combination is small. Hence researchers could well estimate combining weights that indicate that correlations could be exploited for better forecasts only to …nd that the di¤erence in terms of loss is negligible. The results then provide another explanation for the commonly encountered practical situation of the averaging of forecasts being di¢ cult to improve upon. Corresponding author : Graham Elliott, Department of Economics, 9500 Gilman Drive, LA JOLLA, CA, 92109, phone (858) 534 4481, fax (858) 534 7040, email:[email protected].