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Forecasting Inflation and Comparison of Alternative

Univariate ARIMA models

Olaoluwa Vincent Ajayi


Department of Economics, Kingston University London, Penrhyn Rd, KT1 2EE, UK.

Abstract

In this research, we estimate a benchmark model (naïve model) for annual inflation and
compare its forecasting performance with the best selected univariate ARIMA/ARIMAX
specification and the nonlinear TAR model estimated over full sample and a reduced sample
that designed to avoid modelling breaks. This result shows that the benchmark (naïve models)
was never favoured over the both selected nonlinear TAR model and different ARIMA models
for selected countries. Our results also indicate that the models estimated over the reduced
sample exhibit superior forecasting performance compared to the model estimated over the full
sample in most countries. This implies that the potential benefits of having more data from
using the full sample are generally outweighed by being able to avoid modelling structural
breaks, even at the cost of a reduced sample for estimation. Given the extra time and modeller
expertise required to model such breaks this suggests that using reduced samples to avoid the
issue of structural breaks is generally the preferred strategy.

Keywords: ARIMA/ARIMAX; Nonlinear TAR model; Structural breaks; Inflation


forecasting.
JEL Classification Codes: C01, C22, C51, E31.

1. Introduction

It is widely accepted that Inflation in developing countries is caused by monetary and structural
issues while inflation in the developed countries is caused by mainly monetary reasons
(Tavakkoli, 1996). For inflation forecasting, most studies have argued in favour of using
multivariate models over the univariate models although other studies have questioned the
performance of multivariate models over different forecasting horizons (Fritzer et al. 2002,
Onder 2004, Alnaa and Abdalla, 2005). In contrast, Atkeson and Ohanian (2001) showed that
univariate model (naïve model) outperforms multivariate (Phillips curve) in many cases. This
view is supported by Stock and Watson (2007) who revealed that univariate IMA(1,1)
specification are more accurate than the forecasts produced by the multivariate models in
United State for the period of 1960:q1 - 2004:q4. Pretorious and Rensburg (1996) stated that
univariate ARIMA model outperforms multivariate (Phillips curve model, Traditional
monetarist and money demand model) when the inflation is relatively stable and theory based
models are better at forecasting inflation when inflation is volatile. Mitra and Rashed (1996)
showed that the ARIMA model performed better than the other two models during the period
of stable inflation for one- quarter ahead forecasts. For the period of higher inflation and four-
quarter ahead forecasts, the VAR model performed better than the two other models. Lee
(2012) empirical results specified that inflation forecasts generated by the ARIMA model
performed better than inflation forecasts generated by the naïve and Phillips curve models for
most countries, especially for the period following the adoption of the inflation targeting.

The success of univariate model most especially ARIMA model over other selected model
during the period of stable inflation motivated this study to assess the forecasting performance
of different univariate ARIMA specifications and regime shift autoregressive model for
different economies over different period of time, to the best of our knowledge; we are not
aware of any publication that model ARIMAX/ARIMA models and compared its forecasting
performance to the threshold autoregressive model for BRCS and selected OPEC countries
most especially using the Bai and Perron (2003a and 2003b) test to account for time varying
seasonal pattern in annual inflation.1 In our study, we specifically examine the impact of
different approaches on the treatment of seasonality on ARIMA modelling when forecasting
inflation.2 We focus extensively on univariate ARIMA Model to forecast inflation, we compare
the forecasting performance of ARIMAX models estimated over the full sample and different
ARIMA specifications estimated on a reduced sample (with a minimum of 39 observations).
When using the full sample, we produce forecasts for ARIMAX models that have a
deterministic component to account for structural breaks using dummy variables and
seasonality that is modelled using seasonal dummy variables and seasonal AR and MA terms.
The reduced sample modelling is designed to avoid structural breaks such that there is no need
for deterministic terms to model such shifts. The first set of ARIMA models are developed
using the reduced sample and include seasonal dummy variables and seasonal AR and MA
components. A second set of ARIMA models developed for the reduced sample employ
EViews 9’s automatic seasonal ARIMA model specification routine. A third set of ARIMA

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The recent literature that close to our methodology is the empirical study of Ozmen and Sanli, (2017). The
difference between this study and our approach is that Ozmen and Sanli study mainly focused on selecting the
best fitted model for ARIMA and this study does not compare the best selected SARIMA to other alternative class
of model. Therefore, it is very difficult to justify the performance of the best selected SARIMA model over
alternative model. Second, Ozmen and Sanli study applied HECY and Canova- Hansen (CH) test to determine
order of seasonal differencing on monthly Turkish inflation and later applied seasonal ARIMA based on stepwise
and non-stepwise selection. The limitation of this study to our research is that, the study of Ozmen and Sanli does
not include deterministic model to capture the effect of both seasonality and seasonal unit root. Therefore,
imposing one type of seasonality method, when another should be considered may likely have effect on inflation
forecasting. Third, Ozmen and Sanli study only considered one emerging economy. Therefore, it is very difficult
to justify the conclusion of this study to other different economy environment.
2
The three approaches to the treatment of seasonality mentioned by Cosar (2006) were considered. The first
approach is to remove the seasonal component of a series through the use of deterministic dummies. The second
is to use seasonal differencing, or by the use of seasonal adjustment methods like the X-13 Arima or
Tramo/Seats. The third approach is to model the seasonality.

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models were developed for the reduced sample where the data are first seasonally adjusted and
EViews 9’s automatic non-seasonal ARIMA model specification routine is employed. In this
latter case forecasts are re-seasonalised using the 2012 seasonal indices obtained from the
seasonal adjustment procedure. The other univariate model we considered include the regime
shift threshold Autoregressive model (over the full sample and reduced sample) and the naïve
model which added as a benchmark. We seek to assess the following. First, whether superior
forecasts can be obtained by using the full sample (with the benefit of more information) and
explicitly modelling the structural breaks (with the possibility of overfitting and difficulty in
adequately capturing such effects) or whether using reduced samples (with the disadvantage of
fewer data points) is compensated by the avoidance of having to model any structural breaks.
Second, whether quick automatic ARIMA selection procedures available in EViews’s can
produce as good forecasts as specifications produced using more time-consuming model
building techniques. Third, whether ARIMA specifications that explicitly model seasonality
are superior to specifications that apply non-seasonal models to seasonally adjusted data
followed by reseasonalising the forecasts. Fourth, whether regime shift threshold
autoregressive model (TAR model) produces superior forecasts over the univariate ARIMA
model selection? Lastly, of all the models considered, which model produces the best
forecasting performance over the benchmark model (naïve) across countries and/or for
different forecasting horizons?

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2. Literature review
Evidence from previous studies showed that ARIMA model is the best to forecast inflation in
the short horizons. For example, Akhter (2013) estimates ARIMA (1,1,1) (1,0,1)12 and
produce a forecast for inflation for the period 2013 using monthly consumer price data between
January 2000 to December 2012. The study revealed that ARIMA model is valid to produce
the short-term forecast for Bangladesh for 2013. Also, Abdulrahman et. al. (2018) examined
whether the short term ARIMA models can be used to produce inflation forecast in Sudan
between the period 1970 to 2016. The result shows that there is a convergence between
predictive values and actual values during the estimated period. This result implies that a valid
ARIMA model can be obtained to forecast inflation in Sudan during the estimated period.

Study also show that when the ARIMA model is estimated and compared with other selected
models. ARIMA model mostly performs better than alternative models (e.g. Naive model and
multivariate VAR models) during periods of low and stable inflation than a period of high
inflation volatility. For example, Mitra and Rashed (1996) forecast Canadian inflation for one
and four quarters ahead and compared the predictive performance of VAR, ARIMA and Static
expectation models between 1972:q1 and 1986:q4. The series is divided into different samples
to reflect different periods economy environment (period of stable inflation and higher
inflation). The evidence revealed that the ARIMA model performed better than the other two
models during the period of stable inflation for one- quarter ahead forecasts. For the period of
higher inflation and four-quarter ahead forecasts, the VAR model performed better than the
ARIMA and Static model. Lee (2012) compares the predictive performance of the ARIMA
model, Phillips curve and naïve model for twenty-six countries that had adopted a policy of
inflation targeting since 1990. The period before the adoption of the policy and the period after
the inflation targeting policy were implemented. The results specified that inflation forecasts
generated by the ARIMA model performed better than inflation forecasts generated by the
naïve and Phillips curve models for most countries, especially for the period following the
adoption of the inflation targeting policy. To examine effect of structural changes on ARIMA
inflation forecasting. Junttila (2001) estimates two different ARIMA models to forecast
Finnish inflation between the period 1/1978 – 9/1996. The estimated period is characterised by
the period of high unemployment, high inflation, massive rise in house market and the effect
of the collapse of the Soviet Union that accompanied by the recession in Western markets. The
first ARIMA is estimated over the whole sample period without identifying the possible breaks.
While the second ARIMA model follows the study of Tsay (1988) and estimate ARIMA model
with the deterministic model to account for possible breaks. Junttila examines whether the
forecast of inflation obtained from ARIMA model that account for structural breaks produce
better forecast than alternative ARIMA model estimated without modelling breaks. From the
recursive forecast, the result showed that the ARIMA model estimated with intervention
models perform better than alternative ARIMA model estimated without breaks. Instead of
modelling breaks, Doguwa and Alade (2013) estimated seasonal ARIMAX model that
incorporates different macroeconomic variables as an exogenous. The author compares
forecast performance of the seasonal ARIMA model estimated with exogenous to seasonal

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ARIMA model estimated without exogenous for Nigeria between July 2001 to September 2013
over the 12 months forecast horizon. The seasonal ARIMA estimated with exogenous performs
better than the alternative model. Finally, Ozmen and Sanli, (2017) advanced on HECY test
and applied both Osborn, Chui, Smith and Birchenhall (OCSB) test and Canova- Hansen (CH)
test to determine order of seasonal differencing on monthly Turkish inflation and later applied
“auto arima” function in “R software” chosen by stepwise and non-stepwise selection
procedure to select the best fitted ARIMA model. The result shows that the R software
automatic seasonal ARIMA model selected by non-stepwise produce the best fitted SARIMA
when compared with alternative ARIMA selection. The main conclusion from this section is
that the univariate ARIMA model produces a better forecast in a period of low inflation than a
period of high inflation. Also, the ARIMA model estimated to account for structural breaks or
incorporated with other exogenous variables outperform alternative ARIMA model estimated
without structural breaks or other exogenous variables.

3. Empirical methods
When series are quarterly, it is possible that the series will exhibit seasonality, and modelling
of such series requires the non-seasonal ARIMA model to be extended to accommodate
additional features of seasonality. In ARIMA modelling, seasonality can be dealt with in two
different ways: direct seasonal modelling of unadjusted data and by using seasonal adjustment
procedure. The adjusted seasonal method will seasonally adjust the data through, for example,
the X-13 or X-12 procedures and a non-seasonal ARIMA model can be used to forecast the
adjusted data. After which the identified seasonal indices are used to re-introduce the
seasonality into the forecasts. The unadjusted data method directly extends the non-seasonal
ARIMA model to capture the seasonal component of the series. In general, the seasonal
ARIMA model can be expressed as ARIMA (p,d,q)(P,D,Q)s. That is, there is a combination
of two polynomials generated by (p,d,q) and (P, D,Q)s, where P is the seasonal order of the
autoregressive component, D denotes the seasonal order of integration and Q represents the
seasonal order of moving average component. The parameter p, d, and q are the corresponding
non- seasonal orders of processes. The multiplicative seasonal ARIMA mode can be expressed
as follows:3
ø𝑝 (𝐵)ø𝑃 (𝐵 𝑠 )(1 − 𝐵)𝑑 (1 − 𝐵 𝑠 )𝐷 𝑌𝑡 = θ𝑞 (𝐵)θ𝑄 (𝐵 𝑠 )𝑢𝑡
(1)

Where B is the standard backward shift operator defined by BK𝑦𝑡 = 𝑦𝑡−𝑘 , ø𝑝 (𝐵) denotes the
nonseasonal autoregressive model, ø𝑃 (𝐵 𝑠 ) represents the seasonal autoregressive model, θ𝑞 (𝐵)
describes the nonseasonal moving average process, θ𝑄 (𝐵 𝑠 ) denotes seasonal moving average
process, and 𝑢𝑡 is a sequence of white noise errors that are assumed to have zero mean and
constant variance. (1 − 𝐵)𝑑 and (1 − 𝐵 𝑠 )𝐷 are the nonseasonal and seasonal differencing
operators, respectively. Finally, 𝑠 denotes the number of periods in the seasonal cycle.
Therefore:

3
Tseng and Tzeng, 2002; Zhang and Qi, 2005; Wang et al. 2012

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ø𝑝 (𝐵) = (1 - ø1 𝐵 - ø2 𝐵 2 - ø3 𝐵 3 -...........− ø𝑝 𝐵 𝑝 ) (2)

ø𝑃 (𝐵 𝑠 ) = (1- ø1𝑆 𝐵 𝑠 – ø2𝑆 𝐵 2𝑆 – ø3𝑆 𝐵 3𝑆 - ........- ø𝑃𝑆 𝐵 𝑃𝑆 ) (3)

θ𝑞 (𝐵) = (1 - θ1 𝐵 - θ2 𝐵 2- θ3 𝐵 3 -..........− θ𝑞 𝐵𝑞 ) (4)

θ𝑄 (𝐵 𝑠 ) = (1- θ1𝑆 𝐵 𝑠 – θ2𝑆 𝐵 2𝑆 – θ3𝑆 𝐵 3𝑆 - ........- θQ𝑆 𝐵 Q𝑆 ) (5)

Furthermore, an ARIMA model can be amended to incorporate independent exogenous


variables to account for outliers and/or structural breaks. This could be referred to as an
ARIMAX model.4 The modelling of the outliers/breaks can take different forms such as: step-
shift, pulse, split trend or slope - shift.
In this case, the ARIMAX model can be specified as:

θ(𝐵)
𝑦𝑡 = 𝛽0 + 𝛽1 𝐷𝑖𝑡 𝑋𝑖𝑡 + 𝛽2 𝐷2𝑡 𝑋2𝑡 + ⋯ + 𝛽(𝐾−1) 𝐷(𝐾−1)𝑡 𝑋(𝐾−1)𝑡 + ∅(𝐵) e𝑡 . (6)
Where 𝑦𝑡 is the dependent variable, 𝑘 − 1 is the intervention variable, 𝐷𝑖𝑡 is the dummy
θ(𝐵)
variable, 𝛽0 and 𝛽𝑖 are the coefficients, 𝑋𝑖𝑡 are the explanatory variables, 𝑢𝑡 = e, i.e the
∅(𝐵) 𝑡
error term that is modelled by a univariate ARIMA(p,d,q). In our study, we focus on modelling
outliers and structural shifts using the dummy variables, 𝐷𝑖𝑡 , and we do not add any explanatory
variables, 𝑋𝑖𝑡 . And the step intervention allocates dummy variables as follows:
0 𝑖𝑓 𝑡 ≤ 𝑡𝑖
𝐷𝑖𝑡 = {
1 𝑖𝑓 𝑡 > 𝑡𝑖
Where 𝑋𝑖𝑡 = 1 (one outlier or break)

In this case, we model the possible intervention for annual rate of inflation in form of OLS and
apply the Bai Perron test for potential multilpe breaks. The details are given below:
𝑦𝑡 = 𝛿1 𝑆1𝑡 + 𝛿2 𝑆2𝑡 + 𝛿3 𝑆3𝑡 + 𝛿4 𝑆4𝑡 + 𝛿5 𝑡 + 𝜀𝑡 (7)

Where 𝑦𝑡 = annual inflation, the seasonal dummy variables are denoted as: 𝑆1𝑡 , 𝑆2𝑡 , 𝑆3𝑡 and
𝑆4𝑡 , and the time trend, 𝑡 =1,2,…., 𝑇, where 𝑆𝑠𝑡 = 1 in quarter 𝑆 = 1, 2, 3, 4. Further, we specify
shift dummy variables (that are zero prior to the break date and unity from the break date
onwards) interacted with the seasonal dummy variables to develop deterministic for ARIMAX
model. The contemporary equation can be written as:
𝐽 𝐽
𝑦𝑡 = 𝛾1 𝑆1𝑡 + 𝛾2 𝑆2𝑡 + 𝛾3 𝑆3𝑡 + 𝛾4 𝑆4𝑡 + ∑𝐽=1 𝛾1𝐽 (𝐷𝐽𝑡 × 𝑆1𝑡 ) + ∑𝐽=1 𝛾2𝐽 (𝐷𝐽𝑡 × 𝑆2𝑡 ) +
𝐽 𝐽 𝐽
∑𝐽=1 𝛾3𝐽 (𝐷𝐽𝑡 × 𝑆3𝑡 ) + ∑𝐽=1 𝛾4𝐽 (𝐷𝐽𝑡 × 𝑆4𝑡 ) + 𝛾5 𝑡 + ∑𝐽=1 𝛾5𝐽 (𝐷𝐽𝑡 × 𝑡) + 𝑤𝑡 (8)

4
Akal (2004) documents that ARIMAX modelling corrects the deficiencies of the econometric causal-effect
technique by using dynamic filters to explain the variations in endogenous variables.

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Where 𝐷𝐽𝑡 denote the 𝐽 dummy variables corresponding to 𝐽 Identified break dates that are
equal to zero prior to the break data and equal to one on after the break date and 𝑤𝑡 is the
stochastic error term. To justify the need to include the interaction terms in the equation (8),
we applied the t-test to test for the significance of the coefficient of the break point (𝐷𝑖𝑡 ). In
our study, we exclude all insignificant break points and include only dates that are significant.

Following Hendry (2001), Hendry and Santos (2005) and Caporale et al. (2012), we construct
an index of indicator variables to summarise the deterministic terms of the equation (8) in a
single variable to enhance the efficiency of estimation of the ARIMAX model. We regard this
indicator as the fitted value of the deterministic model and regress annual inflation on the
indicator. Further, we plot the graph of the autocorrelation function (ACF) and partial
autocorrelation function (PACF) of the residuals of this model and build possible ARIMAX
model that passes the diagnostic checks of invertibility, stationarity and no autocorrelation for
each country.

The summary of ARIMAX model that passes diagnostic test for each country is given in Table
1 and 2 and details of ARIMAX model that include intervention are specified below:

𝑦𝑡 = I_(P) +𝜽(𝑩)−1 𝜣(𝑩)−1 𝝓(𝑩)𝞥(𝑩)𝑤𝑡 (9)

Where, I_(P) denote a single indicator index used to summaries the deterministic terms in
equation (8).

𝝓(𝑩) =(1 − 𝜙1 𝐵 − 𝜙2 𝐵 2 − ⋯ 𝜙𝑃 𝐵 𝑝 ), 𝞥(𝑩) = (1 − Φ1 𝐵 − Φ2 𝐵 2 − ⋯ Φ𝑃 𝐵𝑃 ),

𝜽(𝑩) =(1 − 𝜃1 𝐵 − 𝜃2 𝐵 2 − ⋯ 𝜃𝑃 𝐵 𝑞 ), 𝜣(𝑩) =(1 − 𝛩1 𝐵 − 𝛩2 𝐵 2 − ⋯ 𝛩𝑃 𝐵𝑄 ), 𝐵 𝐿 𝑃𝑡 = 𝑃𝑡−𝐿


denote the standard backshift operator and 𝑝 and 𝑃 denote the respective orders of non-
seasonal and seasonal autoregressive (AR) processes and 𝑞 and 𝑄 denote the respective orders
of non seasonal and seasonal moving average (MA) processes.

4. Threshold Autoregressive Model

Our expectation follows that presence of structural breaks may mean that inflation may not be
stationary in high inflation economies such as in many OPEC countries because, for example,
a downward shift in the intercept (seasonal indices), coinciding with a move from high to low
inflation eras or fluctuation of the global oil price may give a non-constant mean across the
whole sample period. Therefore, the non- linear model that can be used to capture this
behaviour is the threshold autoregressive (TAR) model first proposed by Tong (1978) and
discussed in detail by Tong and Lim (1980) and Tong (1983).

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TAR is considered as the self-exciting threshold autoregressive (SETAR) model when the
threshold variable is taken as the lagged value of the time series being modelled. The SETAR
assumes that a variable 𝑦𝑡 is a linear auto- regression within a regime but may move between
regimes depending on the value taken by a lag of 𝑦𝑡 , say, 𝑦𝑡−𝑑 where 𝑑 is the length of the
delay.
The simple AR(𝑝) model for a time series {𝑦𝑡 } follows the process:

𝑦𝑡 = 𝝓0 + 𝝓1 𝑦𝑡−1 +…. + 𝝓𝑝 𝑦𝑡−𝑝 + 𝜎𝜀𝑡 (10)

Where 𝝓𝑖 (𝑖 = 1,2,…, 𝑝) are the AR coefficients, 𝜀𝑡 ˷ 𝑁(0,1) and 𝜎 > 0 is the standard
deviation of the disturbance term. The model parameters 𝝓 = (𝝓0 , 𝝓1 , 𝝓2 , … . . , 𝝓𝑝 ) and 𝜎 are
independent of time 𝑡 and remain constant. To capture nonlinear dynamics, TAR models can
be estimated as follow:

𝑦𝑡 = 𝝓𝑜 (𝑗) + 𝝓1 (𝑗) 𝑦𝑡−1 +…...+ 𝝓𝑝 (𝑗) 𝑦𝑡−𝑝 + 𝜀𝑡 (𝑗) if 𝑟𝑗−1 < 𝑧𝑡 ≤ 𝑟𝑗 , (11)

Where 𝑗 = 1, 2, … . , 𝑘, 𝑧𝑡 = 𝑦𝑡−𝑑, . The threshold is - ∞ = 𝑟0 < 𝑟1 < … < 𝑟𝑘 = ∞.; for 𝑗. 𝑘 is


the number of regimes separated by 𝑘 − 1 nontrivial thresholds, {𝜀𝑡 (𝑗) } are independent
identical distributed sequences with zero mean and variance 𝜎𝑗 2 and are mutually independent
for different 𝑗. The parameter 𝑑 is the delay parameter, 𝑟𝑗 are thresholds, 𝑝 is denotes the AR
order and 𝝓𝑝 are the autoregressive coefficients. The summary of the valid TAR model
that passes diagnostic test for each country is given in Table 3 and 4.

Further, we estimate the naïve model as a benchmark model and compare its forecasting
performance with the best selected ARIMA and TAR specifications. The naïve model is
estimated by equating the observed value in the last quarter of the estimation period to forecast
the present quarter. That is:

𝑦𝑇+ℎ = 𝑦𝑇 (12)

where 𝑦𝑇+ℎ is the ℎ period ahead forecast and 𝑦𝑇 is the observed data in the last period of the
estimation sample.

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5. Emprical Data and Results
In this study, we considered the consumer price index that is quarterly and available from
International Financial Statistics (IFS) published by the International Monetary Fund (IMF) for
all selected countries.5 The availability of the sample for each country is varies and available
in the Table 1 and 2. The valid model for both reduced sample and full sample are also available
in the Table 1 and 2 for ARIMAX/ARIMA and Table 3 and 4 for nonlinear threshold model.

5
For all countries, we transformed the consumer price data into annual inflation using the following formula:
𝑃 −𝑃
𝐼𝑁𝐹𝑡 = 𝑡 𝑡−4. Where 𝐼𝑁𝐹𝑡 denote annual inflation rate, 𝑃𝑡 = denotes consumer price index at first quarter
𝑃𝑡−4
and 𝑃𝑡−4 denotes consumer price index at the fourth quarter

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Table 1. Summary of the univariate ARIMA specification for BRICS countries
Countries Brazil
Russia India China South Africa
Sample 1984Q1 1997Q2 1996q1 2003Q2 1961Q1 1992Q1 1961q1 1995Q2
2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4
(116) (63) (68) (39) (208) (84) (208) (71)
Model ARIMAX R_SARIMA R_A_SARIMA R_A_ARIMA ARIMAX R_SARIMA R_A_SARIMA R_A_ARIMA F_SARIMA F_A_SARIMA F_A_ARIMA F_SARIMA F_A_SARIMA F_A_ARIMA ARIMAX R_SARIMA R_A_SARIMA R_A_ARIMA

ARIMA (1,0) (0, 4) (1,1) (0,4) (0,5) (1, 3) (2,2) (1,3) (4,3) (1,3) (1,3) (2,3) (3,2) (1, 4) (1,1) (1, 1) (1,1) (2,2)
(2,1) (0,1) (2, 2,) (0,0) (0,1) (1,0) (0,1) (0,1)
I_(P) 0.93 1.01 -0.04
(22.88) (14.42) (6.42)

AR Root 0.85 0.95 0.82 0.98 0.64 0.69 0.56 0.63 0.81 0.97 0.91 0.99 0.996 0.79 0.86
0.62 0.94 0.62 0.42 0.92 0.88 0.974

MA Root 0.99 0.99 0.99 0.964 0.99 0.99 0.99 0.99 0.99 0.9 0.91 0.99 0.99 0.99 0.46 0.974 1.00 0.99
0.98 0.804 0.99 0.95 0.99 0.99 0.87 0.93 0.86 0.763 0.76
P[QLB] 0.40 0.35 0.54 0.77 0.52 0.08 0.00 0.29 0.16 0.04 0.26 0.16 0.21 0.66 0.18 0.11 0.61 0.35

Table 2. Summary of the valid univariate ARIMA specification for OPEC Countries
Countrie Algeria Angola Nigeria Saudi Arabia Ecuado Kuwait
s r
Sample 1978Q1 1999Q2 1996Q1 2000Q4 1964Q1 1998Q4 1975Q1 1979Q3 1987Q1 1977q1
2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012Q4 2012q4
(140) (55) (68) (49) (196) (57) (152) (134) (104) (140)
Model ARIMAX R_SARIM R_A_SARIM R_A_ARIM ARIMAX R_SARIM R_A_SARIMA R_A_ARIM ARIMAX R_SARIM R_A_SARIM R_A_ARI ARIMAX R_SARIM R_A_SARIMA R_A_ARI ARIMAX ARIMAX
A A A A A A A MA A MA
ARMA (4,4) (1, 0) (1,0) (0, 3) (1, 2) (1, 3) (3,0) (1, 3) (1,2) (2, 0) (1,1) (0, 3) (1,4) (2,1) (2,1) (1, 4) (0,2) (1,3)
(1,0) (0,1) (0,1) (0,1) (1,0) (0,1) (1,0) (1,0) (0,1) (0,1)
I_(P) 0.93 0.22 0.41 0.59 0.25 0.57
(22.88) (65.17) (6.74) (10.88) (6.67) (21.04)
AR Root 0.93 0.99 0.98 0.70 0.81 0.99 0.98 0.98 0.81 0.76 0.73 0.98 0.98 0.91 0.98 0.35
0.86 0.87 0.65 0.57 0.88

MA Root 0.97 0.99 0.99 0.99 0.99 0.99 0.99 0.99 1.00 1.00 0.99 0.99 0.99 0.99 0.99 0.91
0.88 0.92 0.30 0.61 0.46 0.42 0.99 0.61 0.81 0.89 0.69 0.94

P[QLB] 0.06 0.43 0.73 0.61 0.11] 0.05 0.05 0.02 0.18 0.41 0.97 0.29 0.14 0.11 0.08 0.09 0.12 0.31
Where P[QLB]= Probability value of the Ljung-Box Q-statistic at that based on the square root of the sample size, AR Roots = Stationary Autoregressive average, MA Roots = Stationary Moving average, LR(SEA DUM) =
the joint test for the seasonal dummy variables, Rounded Bracket = T – Ratios and Square Bracket = Probability value. I_(P ) = is an index indicator variable for seasonal shifts embodied as the deterministic terms
is an index indicator variable for seasonal shifts embodied as the deterministic terms

10
The full sample univariate model that employs seasonal Box-Jenkins ARIMA techniques and model’s structural
breaks is denoted as ARIMAX. The full sample univariate model that employs Box-Jenkins ARIMA techniques
without modelling structural breaks is denoted as F_SARIMA (this model type is exclusive to India and China
because there were no significant structural breaks to model over the full sample for India, and the period after
the structural breaks are less than 39 observations for China. However, the breaks identified in China are relative
step shifts that appear to be small which mean that inference regarding unit roots may not be too adversely affected
when using the full sample. Hence, we considered the full sample for both China and India. The full sample
specifications that employ EViews 9’s automatic seasonal and non-seasonal ARIMA model without modelling
breaks are denoted as F_A_SARIMA and F_A_ARIMA respectively. The reduced sample model that employs
seasonal ARIMA technique’s without modelling structural breaks is denoted as R_SARIMA. The reduced sample
model that employs EViews 9’s automatic seasonal ARIMA model selection procedure without modelling breaks
is denoted as R_A_SARIMA and the reduced sample model that employs EViews 9’s automatic non-seasonal
ARIMA model selection method without modelling breaks is represented by R_A_ARIMA. F_TAR Model is
denoted as threshold autoregressive model estimated over the full sample and R_TAR model is denoted as the
threshold autoregressive model estimated over the reduced sample that avoid modelling breaks.

Table (1 and 2) above summarises the favoured different ARIMAX and ARIMA specifications
for all BRICS and OPEC countries. For ARIMAX model estimated over the full sample and
include deterministic model to capture the structural breaks, the indicator index of the
deterministic model (I_P) is significant for all the countries and none of the selected models
could be rejected for the standard diagnostic of residual autocorrelation, stationarity and
invertibility (see row labelled AR, Root, MA Root and P[QLB] in the table 1 and 2). For the
favoured ARIMA specifications over a reduced sample that design to avoid modelling breaks.
For seasonal ARIMA (R_SARIMA), none of the selected models could be rejected for the
standard diagnostic of residual autocorrelation, stationarity and invertibility. However, 4 of the
9 selected countries failed the standard diagnostic test for seasonal automatic selected models
(R_A_SARIMA) and (F_A_SARIMA). In particular, three of the 5 BRICS countries’
automatically selected models fail the standard diagnostic checks for autocorrelation (Russia
and India) and invertibility (South Africa). Only Nigeria failed the standard diagnostic checks
(for invertibility) in the selected OPEC countries. Where non-seasonal ARMA models
automatically developed (R_A_ARIMA), none of the automatically selected models could be
rejected for the standard diagnostic (residual autocorrelation, stationarity and invertibility) that
we conduct for the 5 BRICS countries. However, for 2 of the 4 selected OPEC countries the
automatically selected models failed the diagnostic checks for autocorrelation (Angola) and
invertibility (Nigeria). This implies that the automatic selection procedure often selects models
that failed the standard diagnostic or select variables that would be considered for exclusion by
a modeller. It will be interesting to see whether this has an impact on the forecasting
performance of these models.

11
Table 3. Summary of the valid TAR models for BRICS countries
Countries Brazil Russia India China South Africa
Full Reduce Full Reduce Full Full Full sample Reduce sample
sample sample sample sample sample sample
Sample 1984Q4 1997Q2 1996Q1 2003Q2 1961Q1 1992Q1 1961q1 1995q2-2012q4
2012q4 2012q4 2012q4 2012q4 2012q4 2012q4 2012q4
Lags values 3 3 6 2 5 10 6 6
Regimes 1 2 2 2 2 1 2 2
Threshold 0.07 0.24 0.08 0.11 0.85 0.11
value for 1 [41] (57] [32] [166] [160] [60]

Threshold 0.07 0.24 0.08 0.11 0.85 0.11


value for 2 [22] [11] [32] [42] [48] [11]
LM[RESID] 0.09 0.99 0.08 0.39 0.07 0.18 0.13 0.77
LM 0.45 0.08 0.26 0.71 8.73 3.42
(Obs*R-
squared) 2.56 0.25
Where LM[RESID ()] = p value of the residual, LM (Obs*R-squared) = probability value of Breusch- Godfrey
LM test.
Table 4. Summary of the valid TAR models for selected OPEC countries
Countries Algeria Angola Nigeria Saudi Kuwait Ecuador
Arabia
Full Reduce Full Reduce Full Reduce Full Reduce
sample sample sample sample
sample sample sample sample
Sample 1978Q1 1999Q2 1996q1 2000Q4 1964q1 1998Q4 1975Q1 1979Q3 1977q1 1987q1
2012q4 2012q4 2012q4 2012q4 2012q4 2012q4
2012q4 2012q4 2012q4 2012q4
Lags values 7 5 3 2 15 6 10 8 5 3
Regimes 3 2 1 2 2 2 2 3 2 3
Threshold 0.09 0.01 1.12 0.37 0.15 0.05 0.004 0.06 0.44
value for 1 (83] [25] [19] [165] [24] [130] [51] [115] [72]

Threshold 0.09 0.01 1.12 0.38 0.15 0.05 0.004 0.06 0.44
value for 2 [24] [30] [30] [28] [33] [22] [63] [29] [15]

Threshold 0.15 0.05 0.54


value for 3 [33] [20] [17]

LM[RESID] 0.32 0.16 0.11 0.05 0.25 0.39 0.16 0.31 0.18 0.97
LM 0.21 0.35 0.08 0.05 0.95 0.26 0.27 0.56
(Obs*R- 0.81
squared) 0.12
Where LM[RESID ()] = p value of the residual, LM (Obs*R-squared) = probability value of Breusch- Godfrey
LM test.

Table (3 and 4) above summarised the favoured TAR model estimated over the full sample a
reduced sample that avoid that avoid modelling breaks. For both BRICS and OPEC countries,
we noticed that the TAR specifications estimated over the full sample identified at least two
regimes for all selected countries except China and Brazil for BRICS countries and only
Angola for OPEC countries. Whereas, the TAR model estimated over the reduced sample
identified minimum of two regimes for all selected countries for both BRICS and OPEC
countries. We also noticed all the estimated TAR models passed the diagnostic test for both
series (LM (Obs*R-squared) and residual autocorrelation (LM[RESID]. This result implies
that regime shift TAR model is appropriate to model and forecasting inflation in most of the
selected countries.

12
6. Forecast performance and evaluation
In this section, we estimate a benchmark model (naïve model) for annual inflation and compare
its forecasting performance with different univariate ARIMA/ARIMAX and regime shift
threshold model estimated over the full sample and reduced sample in table 1,2, 3 and 4 to
choose the best model that forecasts inflation in each country. Each model is estimated over a
period that ended in 2012q4 (the start of the estimation period varies across models and
countries). These models are used to produce forecasts over the ex-post forecasting period
2013q1 – 2014q4. These produce 1-step ahead forecasts for 2013q1, 2-step ahead forecasts for
2013q2 and so on up to 8-step ahead forecasts for 2014q4. The identified models were then re-
estimated by adding one observation to the end of the sample, hence the models are estimated
over a period ending in 2013q1. These estimated models are used to produce 1-step ahead
forecasts for 2013q2, 2-step ahead forecasts for 2013q3 and so on up to 7-step ahead forecasts
for 2014q4. This process is then repeated with one observation being added to the estimation
period (with the last rolling regression’s sample period ending in 2014q3), and m-step ahead
forecasts produced up to the end of the forecast period. These rolling regressions produce eight
1-step ahead forecasts, seven 2-step ahead forecasts, six 3-step ahead forecasts, five 4-step
ahead forecasts and so on up to one 8-step ahead forecast for each estimated model. Further,
we compare the forecasting performance of each model over the different number of step ahead
forecasting horizons using the Root Mean Squared Error (RMSE), Mean Absolute Percentage
Error (MAPE) and Theil’s inequality coefficient (U). The best forecasting model, on average,
over any particular horizon will have the lowest value of forecasting performance measures.
The summary of the best forecasting performance measures of each country are given in Table
(5 and 6).

13
5. Summary of the best forecasting univariate models for BRICS countries
RMSE6
Brazil
2_step 3_step 4_step 5_step 6_step 7_step 8_step
ARIMAX 24.352 26.422 28.943 32.364 37.365 19.135 14.919
R_SARIMA 0.006 0.008 0.006 0.004 0.005 0.01 0.002
R_A_SARIMA 0.006* 0.006 0.006 0.007 0.006 0.006 0.009
R_A_ARIMA 0.007 0.006* 0.003* 0.0002* 0.0004* 0.0004* 0.0004*
F_TAR 0.017 0.026 0.031 0.036 0.039 0.042 0.042
R_TAR 0.008 0.011 0.011 0.008 0.004 0.007 0.006
Navie 0.006 0.006 0.004 0.002 0.007 0.008 0.002
Russia
ARIMAX 0.031 0.034 0.046 0.036 0.035 0.032 0.017
R_SARIMA 0.018 0.022 0.023 0.022 0.024 0.026 0.011
R_A_SARIMA 0.028 0.04 0.053 0.056 0.049 0.048 0.029
R_A_ARIMA 0.008* 0.015* 0.016* 0.016* 0.014* 0.016* 0.006*
F_TAR 0.658 0.888 1.067 1.214 1.333 1.43 1.509
R_TAR 0.049 0.078 0.206 0.543 1.077 1.964 4.156
Navie 0.084 0.114 0.203 0.368 0.599 0.991 2.039
China
F_SARIMA 0.01 0.015 0.021 0.025 0.028 0.028 0.031
F_A_ARIMA 0.009 0.015 0.023 0.026 0.039 0.028 0.028
F_TAR 0.005* 0.008* 0.010* 0.012* 0.014* 0.015* 0.011*
Navie 0.026 0.037 0.047 0.057 0.068 0.078 0.105
India
F_A_SARIMA 0.018 0.019 0.023 0.020 0.022 0.024 0.030
F_SARIMA 0.011* 0.019* 0.020* 0.020* 0.021* 0.020* 0.020*
F_TAR 0.023 0.021 0.021 0.021 0.021 0.021 0.034
Navie 0.047 0.057 0.076 0.088 0.102 0.130 0.207
South Africa
ARIMAX 0.051 0.056 0.051 0.043 0.043 0.052 0.051
R_SARIMA 0.023 0.026 0.021 0.012* 0.012 0.012 0.006*
R_A_SARIMA 0.012* 0.013* 0.015* 0.014 0.009* 0.008* 0.012
R_ARIMA 0.059 0.055 0.047 0.023 0.015 0.031 0.021
F_TAR 0.024 0.025 0.038 0.046 0.050 0.049 0.123
R_TAR 0.016 0.021 0.029 0.031 0.031 0.034 0.043
Navie 0.020 0.037 0.047 0.057 0.068 0.078 0.105

See note in the Table 1 and 2

6
We only report the result of RMSE in this table because result produced by the MAPE and U statistics are
similar.

14
6.Summary of the best forecasting univariate models for OPEC countries
RMSE
Angola

1_step 2_step 3_step 4_step 5_step 6_step 7_step 8_step

ARIMAX 0.122 0.191 0.261 0.293 0.399 0.433 0.425 0.288

R_SARIMA 0.012* 0.027* 0.040* 0.057* 0.062* 0.086* 0.094* 0.100*

R_A_ARIMA 0.031 0.069 0.107 0.174 0.251 0.317 0.335 0.401


R_ARIMA 0.067 0.145 0.179 0.191 0.243 0.281 0.113 0.154

F_TAR 0.051 0.056 0.059 0.069 0.069 0.231 0.434 0.443

R_TAR 0.037 0.047 0.057 0.059 0.062 0.102 0.131 0.207

Navie 0.227 0.306 0.384 0.462 0.551 0.666 0.845 1.228

Algeria

ARIMAX 0.012* 0.018 0.016* 0.016* 0.020* 0.016* 0.015* 0.017*

R_SARIMA 0.014 0.027 0.038 0.048 0.049 0.044 0.033 0.021

R_A_ARIMA 0.013 0.015* 0.031 0.041 0.043 0.042 0.042 0.026

R__A_SARIMA 0.014 0.016 0.019 0.024 0.022 0.018 0.017 0.021


F_TAR 0.017 0.027 0.036 0.042 0.044 0.035 0.023 0.019
R_TAR 0.016 0.018 0.024 0.031 0.031 0.026 0.021 0.018
Navie 0.033 0.051 0.063 0.078 0.088 0.091 0.083 0.043
Saudi Arabia

ARIMAX 0.006 0.008 0.007 0.006 0.009 0.009 0.008 0.005

R_SARIMA 0.0030 0.005 0.009 0.013 0.015 0.018 0.021 0.022

R_A_SARIMA 0.004 0.007 0.011 0.014 0.017 0.02 0.025 0.026

R_A_ARIMA 0.005 0.007 0.004 0.002* 0.004* 0.004* 0.001* 0.0004*

F_TAR 0.002* 0.003* 0.002* 0.006 0.008 0.010 0.010 0.011


R_TAR 0.003 0.005 0.005 0.007 0.009 0.010 0.011 0.012

Navie 0.015 0.021 0.023 0.035 0.0447 0.058 0.071 0.109


Nigeria
ARIMAX 0.025 0.044 0.066 0.078 0.086 0.091 0.099 0.123
R_SARIMA 0.017 0.028 0.040 0.046 0.047 0.044 0.043 0.041
R_A_ARIMA 0.024 0.038 0.031 0.032 0.038* 0.035* 0.036* 0.040*
R_A_ SARIMA 0.023 0.027 0.041 0.037 0.058 0.045 0.048 0.045
F_TAR 0.032 0.051 0.056 0.051 0.043 0.043 0.052 0.051

R_TAR 0.014* 0.020* 0.030* 0.031* 0.063 0.066 0.067 0.066


Navie 0.042 0.062 0.086 0.107 0.125 0.148 0.183 0.256
Ecuador

ARIMAX 0.007* 0.009* 0.013* 0.016* 0.015* 0.015* 0.008* 0.010*

F_TAR 0.009 0.015 0.023 0.031 0.033 0.034 0.027 0.011


Navie 0.111
0.030 0.031 0.031 0.031 0.029 0.027 0.013
Kuwait
ARIMAX 0.006* 0.009* 0.013* 0.010* 0.012* 0.011* 0.008* 0.004*
F_TAR 0.007 0.012 0.013 0.011 0.013 0.014 0.009 0.007
Navie 0.025 0.027 0.031 0.032 0.032 0.034 0.036 0.039

See note in the Table 1 and 2

15
7. Empirical Results and Discussion
For BRICS countries, see Table 5, the EViews 9 automatic model selection procedure is
virtually always favoured for all countries except India and China. The reduced sample
automatic seasonal method is favoured for Brazil over the 1 and 2 steps ahead horizons and for
South Africa over the 1 to 4 and 6 to 7-step ahead horizons. The reduced sample automatic
non-seasonal method is favoured for Brazil over the 3 to 8 step horizons and for Russia over
all horizons. The seasonal ARIMA model (without modelling structural breaks) is favoured for
India over all horizons (using the full sample) and is preferred for South Africa over the 5 and
8 step horizons (using a reduced sample). The benchmark model (naïve model) and ARIMAX
model were never favoured for any BRICS countries. The threshold autoregressive model
(using full sample) only favoured for China over all forecasting horizons. In contrast, the
threshold autoregressive model estimated over a reduced sample were never favoured for any
of the BRICS countries.

For OPEC countries, see Table 6 the EViews 9 automatic model selection procedure applied
to the reduced sample is only occasionally favoured and the automatic seasonal method is never
favoured for all forecasting horizons (which contrasts with the results for BRICS countries).
The automatic non-seasonal method is favoured for Algeria over the 2-step horizon, for Saudi
Arabia over the 4 to 8 steps ahead horizons and for Nigeria over 5 to 8 step horizons. The
seasonal ARIMA model (without modelling structural breaks) is favoured for Angola over all
horizons. The ARIMAX model produce a better forecast over all forecasting horizons for
Ecuador, Kuwait and Algeria. The exception is for Algeria over 2-step ahead forecast. The
nonlinear TAR models were not favoured over the best selected linear ARIMA/ARIMAX for
OPEC countries except for Nigeria (over 1 to 4-steps ahead horizons) and Saudi Arabia (over
1 to 3- steps ahead) using a reduced sample and full sample respectively. For all the OPEC
countries, the naïve model was never favoured.

The main conclusion from this table (5 and 6) is that there is no single model that dominates
across all the countries and the best forecasting method varies considerably across the models.
However, the following general findings can be useful for future research. First, when
comparing model estimated over the full sample (ARIMAX and F_TAR model) to the model
estimated over a reduced sample that avoid modelling breaks (e.g. R_ARIMA, R_A_SARIMA
and R_TAR model). The model estimated over the full sample is rarely favoured except for
Kuwait and Ecuador where we only estimated for full sample and Algeria over all forecasting
horizon. For the favoured reducing sample model, the EViews 9’s automatic model selection
procedure is often favoured (especially for the BRICS countries) although seasonal ARIMA
modelling without using automatic model selection is sometimes favoured. Hence, the quick
automatic ARIMA selection procedures often (though not always) produce superior forecasts
compared to more time-consuming Box-Jenkins ARIMA modelling techniques. Of the two
automatic ARIMA model selection procedures considered the non-seasonal method applied to
seasonally adjusted data was more generally favoured than the seasonal method applied to

16
unadjusted data. This suggests that the benefit of seasonally adjusting the data and re-
seasonalising the forecasts generally outperforms the method of explicitly modelling
seasonality. We also noticed that the nonlinear TAR models were not favoured over the best
selected models for BRICS and OPEC countries except for Nigeria (over 1 to 4 steps ahead),
Saudi Arabia (over 1 to 3 steps ahead horizon) and China (over all forecasting horizons).
Hence, there are 3 countries where the TAR model produces the better forecasts than the best
selected univariate ARIMA/ARIMAX specifications over at least some horizons. Lastly, our
study also revealed that the benchmark model (naïve forecast) were never favoured over the
best selected model for BRICS and OPEC countries. This evidence confirmed that using
univariate ARIMA/ARIMAX and TAR models were the better strategies for forecasting
inflation for BRICS and OPEC countries. Our result is consistent with studies of Atkeson and
Ohanian (2001) who argued that an inflation forecasting cannot be considered a useful guide
for policy if its forecasting performance is not better than a simple naïve model.

8. Summary and Conclusion


In this research, we estimate a benchmark model (naïve model) and compare its forecasting
performance with the best selected univariate ARIMA/ARIMAX specification and nonlinear
TAR model. In particular, we produce forecasts for ARIMAX models that have a deterministic
component to account for structural breaks over the full sample period and different ARIMA
specifications over a reduced sample period that avoids structural breaks. The ARIMA models
that we develop over the reduced sample period are, first, a seasonal ARIMA specification
identified using the Box-Jenkins method, second, a seasonal ARIMA model identified using
EView’s automatic model selection tool and, third, a non-seasonal ARIMA model identified
using EView’s automatic model selection tool applied to seasonally adjusted data. For
nonlinear TAR model, the model is estimated over the full sample and reduced sample that
designed to avoid modelling breaks.

From our study, the following conclusions emerge: First, ARIMAX and TAR model that passes
standard diagnostic checks for residual autocorrelation, stationarity and invertibility can be
obtained in all selected countries. Second, when comparing model estimated over the full
sample to the model estimated over a reduced sample that avoids modelling structural breaks,
the model estimated over a reduced sample often exhibit superior forecasting performance
compared to the selected models estimated over the full sample in most countries except for
Algeria. This result is consistent with the notion that models with many regressors, as required
when modelling structural breaks, can overfit the sample and exhibit a poor forecasting
performance (Yohei, 2013 and Carlos, 2014). Third, ARIMA specifications based upon the
EViews 9 automatic model selection procedure are virtually favoured for BRICS countries. For
instance, the EViews 9 automatic model selection procedure is favoured over the seasonal Box-
Jenkins ARIMA model (that does not use the automatic selection technique) for all BRICS
countries except India and China. In contrast, the EViews 9 automatic model selection models
were never favoured for OPEC countries except for Saudi Arabia (over 4 to 8 steps ahead) and

17
Nigeria (over 5 to 8 steps ahead). The performance of the EView automatic selected model for
BRICS countries suggests that automatic selection methods not only have the benefit of saving
time they often also produce superior forecasts. This is despite our finding that ARIMA models
based on automatic selection procedures often fail standard diagnostic checks and/or include
irrelevant regressors. Fourth, when comparing automatic ARIMA model selection
specifications that explicitly model seasonality to those that apply non-seasonal models to
seasonally adjusted data and re-seasonalize the forecasts. We observed that building ARIMA
models to seasonally adjusted data and re-seasonalising the forecasts generally yields superior
forecasting performance relative to constructing seasonal ARIMA models when using
automatic ARIMA model selection procedures. Our result also shows that the benchmark
models (naïve forecast) were never favoured over the best selected ARIMA/ARIMAX and
TAR model for BRICS and OPEC countries. Similarly, the nonlinear TAR models were rarely
favoured over the best selected univariate ARIMA/ARIMAX model for BRICS and OPEC
countries except for Nigeria (over 1 to 4 steps ahead), Saudi Arabia (over 1 to 3 steps ahead
horizon) and China (over all forecasting horizons). Hence, there are 3 countries where the TAR
model produces the better forecasts than the best selected univariate ARIMA/ARIMAX
specifications over at least some horizons. The performance of the TAR model for China,
Nigeria and Saudi Arabia over the few steps are consistent with the studies of Montgomery, et
al. (1998), Tiao and Tsay, (1991), Clements and Smith (1997)., Pippenger and Goering, (1998)
who document that good performance of TAR model over other selected univariate model most
especially during the period of economic recession.

18
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