Dissertation

Distributional Properties of Forecast Errors for Inflation and GDP:
Lessons from the National Bank of the Slovak Republic
Name deducted*
April 2021
Abstract
We investigate whether it is sensible for the National Bank of the Slovak Republic to abandon the assumption
of a split-normal distribution commonly used for fan-chart modelling and replace it with a split-t distribu-
tion. Two parametric distributions are fitted to ex-post empirical observations via the method of maximum
likelihood. In general, we find that the split-t distribution performs competitively to that of the split-normal
in model-fitting for GDP projections, but not for inflation projections. Therefore, we do not find enough
evidence against the use of the split-normal distribution in forecasting applications. The conclusions are
tentative, and further research is advised.
Key words: Forecast uncertainty; Skewed densities; Fan-charts; Model-fitting errors

JEL Classification: C24, C46, C53, E58
∗ Submitted in partial fulfilment of the requirements for the degree of the Master of Arts - MA (SocSci) with Honours,
Economics. I thank Dr Richard Dennis for his guidance and continued support throughout the composition of this paper. This
journey would not have been possible without the support from my family. Likewise, I appreciate the feedback offered by Dr
Marian Vavra from the research department of the National Bank of the Slovak Republic. Dedicated to Louis Ackland. I take
full responsibility for any shortcomings remaining. Email: mtpalovic@gmail.com.
University of Glasgow, Adam Smith Business School.
ECON4006P Economics Dissertation. Student ID: 2331008.
Word count (excl. bibliography): 9015
Table of Contents
1 Introduction 1
2 Literature review 4
2.1 Research methods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
2.1.1 Split-normal distribution in fan-chart modelling . . . . . . . . . . . . . . . . . . . . . . 4
2.1.2 Applications of split-t distribution in other fields of literature . . . . . . . . . . . . . . 5
3 Theoretical Framework 8
3.1 Preliminary Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
3.1.1 The Central Tendency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.1.2 The Degree of Uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
3.1.3 The Balance of Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3.2 A Parametric framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
3.3 Maximum Likelihood Estimation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
3.4 Likelihood Ratio test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
4 Empirical Strategy 15
4.1 Data Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
4.2 Application to the Forecast Error Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
5 Results 20
5.1 Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
5.2 Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
6 Concluding remarks 28
References 30
A Appendix i
A.1 Inflation growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i
A.2 GDP growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii
List of Figures
1 Inflation growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and
Split-t densities fitted to eight-quarter-ahead forecast error data from 2007q2 - 2018q3 . . . . 24
2 GDP growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and
Split-t densities fitted to eight-quarter-ahead forecast error data from 2007q2 - 2018q3 . . . . 25
A.1 Inflation growth: Forecast Error Histogram and Split-Normal . . . . . . . . . . . . . . . . . . i
A.2 Inflation growth: Forecast Error Histogram and Split-t . . . . . . . . . . . . . . . . . . . . . . i
A.3 GDP growth: Forecast Error Histogram and Split-Normal . . . . . . . . . . . . . . . . . . . . ii
A.4 GDP growth: Forecast Error Histogram and Split-t . . . . . . . . . . . . . . . . . . . . . . . . ii
A.5 Inflation growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and
Split-t densities fitted to four-quarter-ahead forecast error data from 2007q2 - 2018q3 . . . . iii
A.6 GDP growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and
Split-t densities fitted to four-quarter-ahead forecast error data from 2007q2 - 2018q3 . . . . iv
List of Tables
1 Parameter Estimates for Split-Normal and Split-t densities for Inflation and GDP fitted to
eight-quarter-ahead Forecast Error Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2 Parameter Estimates for Split-Normal and Split-t densities for Inflation and GDP fitted to
four-quarter-ahead Forecast Error Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
ECON4006 University of Glasgow
1 Introduction
’One message is clear, however: it is dangerous to look at the pattern of model

fitting errors and to assume that the post-sample forecasting errors will not deviate
much from this pattern.’
— Makridakis & Winkler (2016, p.341).
’Holding fixed the available data, and presuming avoidance of deductive errors,
stronger assumptions yield stronger conclusions. At the extreme, one may achieve
certitude by posing sufficiently strong assumptions. The fundamental difficulty of
policy analysis is to decide what assumptions to maintain.’
— Manski (2010, p.2).
Inflation-targeting central banks use density forecasts to communicate the uncertainty around their point
forecasts using fan-charts (Giacomini & Rossi 2015). In particular, the implementation of fan-charts increases
the transparency of central bank communication (Julio-Román 2007) because it explicitly ’acknowledges the
uncertainty that is inherent in any forecast’ (Wallis 1999, p.106). Because there is a lag between monetary
policy action and its response on the economy (Bernanke & Mishkin 1997, Blix & Sellin 1998), ’monetary
policy decision can be understood or (...) [criticised] only on the basis of an economic forecast’ (Smaghi 2006,
p.55). However, even if a forecasting model is only one aspect in establishing the future path of monetary
policy, carefully reviewing its structure [and assumptions] can help inform the public (Robertson 2000). It
is needless to say that if the assumptions underlying the forecasting model are no longer valid, then the
fan-chart itself becomes obsolete and resulting monetary policy action may not be appropriate.
This paper utilises research on the construction of fan-charts. It aims to understand whether the the-
oretical behaviour of the past forecast errors is reflected in ex-post empirical observations. To do this, we
question the assumption of a particular choice of distribution used for fan-chart modelling since its inception
in 1998, namely the split-normal distribution1 . However, Alessi et al. (2014) emphasises the observation
of Stockton (2012) who argues that density forecasting performance during the global financial crisis has
been remarkably worse than before the crisis. Therefore, the forecast errors’ empirical behaviour may have
changed post-crisis. Based on that, there has been ’a groundswell of recent interest’ in modelling economic
1 It is a symmetry-modulated distribution fully characterised by three parameters. Nonetheless, we defer the definition of
terms and description of the split-normal distribution until Section 3 on parameterisation and theoretical framework.
1
systems in response to the global financial crisis (Haldane 2012, p.15), including the volatility of GDP growth
(Adrian et al. 2019). In this regard, Dowd (2007) published an article entitled ’Too good to be true? The
(In)credibility of the UK inflation fan-charts’ in which the main finding is that the Bank of England’s model
over-estimates inflation risk. She writes: ’The MPC [Monetary Policy Committee] thought there was a
significant probability that inflation would not remain within its target range over the horizon to 1999q3.
However, inflation remained within this range every quarter over that horizon period’ (Dowd 2007, p.93).
Importantly, the conclusion implicitly suggests that the split-normal distribution understates the probability
of a modal forecast and that a split-normal distribution may have been too wide. Indeed, this is referred to
as Dowd puzzle in the literature on fan-chart modelling (Makarova, Díaz & Charemza 2013). In addition, as
Galbraith & Norden (2012) notes, Gneiting & Ranjan (2011) reached an analogous conclusion in examining
longer horizon forecasts.
Based on the above, there appear to be some issues with the split-normal distribution in the forecasting
process by central banks. Therefore, we are motivated to build on the work by Mitchell & Weale (2019)
who consider a more flexible density function that nest a split-normal distribution but allow for regulating
kurtosis by introducing an additional parameter. Specifically, the split-t distribution is fitted to past forecast
errors of inflation and gross domestic product, respectively. At the time of writing this paper, only Mitchell
& Weale (2019) have explicitly questioned the choice of statistical distribution for fan-chart modelling. In
addition, Mitchell & Weale (2019) have offered an exploration into the suitability of a similar family of distri-
butions that could better reflect the past forecast errors than the split-normal distribution. They stress that
central banks have focused too much on the modal forecast and not as much on the shape of the distribution
underlying past forecast errors in recent years (Mitchell & Weale 2019). Therefore, this paper hopes to offer
only the second input in the literature on the choice of distribution for fan-chart modelling. Indeed, this
paper’s larger objective is to draw attention to the fact that the assumptions used for economic modelling
may change as time varies.
Further, the difficulty in seeking distribution in the context of fan-chart modelling reflects the fact that
the distribution itself may change as the choice of estimation window is amended (Mitchell & Weale 2019).
This observation is also confirmed by Adrian et al. (2019) who find that the entire distribution, and not just
the central tendency, is time-varying. Thus, it is essential for scholars and researchers to always question the
assumptions used for the work published. Because the National Bank of the Slovak Republic also publishes
its forecast predictions through fan-charts, we explore whether the findings of Mitchell & Weale (2019) can
be generalised to other inflation-targeting central banks worldwide.
2
To answer the research question of this study: Is forecast errors better represented by a split-t distri-
bution rather than a split-normal?, the remainder of this paper is structured as follows. Section 2 reviews
the relevant literature on fan-chart modelling. Section 3 defines the terms and presents the two parametric
distributions, the split-normal and the split-t, respectively. Section 4 describes the forecast error data. The
results are discussed in Section 5 and interpreted in Section 5.1. Limitations of this work are discussed in
Section 5.2. Section 6 concludes and offers promising avenues for further research.
Above all, we open the research question to offer some answers. However, we do not claim to settle the
matter on fan-chart modelling fully. Finally, we invite other scholars to investigate this issue further.
3
2 Literature review
The objective in this section is first to discuss the applicability of the split-normal distribution for fan-
chart modelling, as it is standard practice for inflation-targeting central banks around the globe (see Section
2.1.1). Based on the potential issues with the use of a split-normal distribution in recent years2 , the split-t
distribution is suggested for fan-chart modelling. The use of this distribution is discussed in other empirical
applications first before exploring its potential suitability in the framework of fan-chart modelling. However,
the literature on using the split-t distribution for fan-chart modelling is limited when writing this paper.
Therefore, this paper hopes to fill this gap in the literature.
2.1 Research methods
2.1.1 Split-normal distribution in fan-chart modelling
The symmetric gaussian distribution is the most favoured and well-liked distribution used for modelling in
economics and finance (Eling 2012). However, it gives a beguilingly simple description of the world (Hal-
dane 2012). The limitation of the gaussian distribution for fan-chart modelling stems from its inability to
capture the asymmetry of upside and downside risks (Pońsko & Rybaczyk 2016). As a result, the symmetric
gaussian distribution is extended by the introduction of a skewness parameter to capture balance of risks
(Blix & Sellin 1998, Britton et al. 1998), which resulted in a split-normal distribution3 . The split-normal
distribution emerged in public view in the late 1990s, when the Bank of England and the Sveriges Riksbank
adopted this distribution as a means to illustrate the fact that the balance of risks around the central forecast
may not be symmetric (Wallis 2014). There are various parameterisations for a split-normal density (Julio-
Román 2007). The parameterisation suggested by John (1982) is adopted here because it is the preferred
parameterisation by most inflation-targeting central banks4 . In most instances, the maximum likelihood
method is adopted to estimate the parameters of the distribution (Wallis 2014). Skewness and kurtosis5 are
salient aspects of the distribution in the framework of modelling predictive densities because the shape of
the underlying distribution is reflected therein (Rubio & Steel 2015). Perhaps, the justification for using the
split-normal arises from its mathematical tractability, implying that the maximum likelihood equation for a
random sample of n may readily be written down (Henze 1986). For an overview of various generalisations of a
scalar split-normal distribution and its use in empirical applications, see Makarova, Charemza & Díaz (2013).
2 We present some issues associated with the use of the split-normal distributions in forecasting applications in Section 1 and
2.
3 The split-normal distribution is defined as f (y ; γ) = 2φ(y )ϕ(γy ); γ ∈ R; where φ, ϕ are the standard normal density and
t t t
distribution function, respectively (Azzalini 1985). See also John (1982).
4 The selective list of inflation-targeting central banks that use the split-normal distribution for forecasting purposes is
provided in Section 3.
5 Rubio & Steel (2015) do not distinguish between different types of kurtosis, i.e. mesokurtosis, leptokurtosis, or platykurtosis.
However, a visual inspection of their plotted distributions suggests leptokurtosis with fat tails and most values concentrated
around the mean.
4
The methodological approach adopted by inflation-targeting central banks is primarily based on the past
forecast errors on the premise of a normal distribution of predictive density (Razi & Loke 2017). However,
several studies rejected the assumption of normality. This provokes the abandonment of a split-normal distri-
bution and motivates the search for alternative distribution, for example a split-t distribution. For example,
Vavra (2018, p.11) explores the distributional properties of past forecast errors, primarily normality and
symmetry, in G7 countries and draws the following conclusion: ’...from the previous results that normality is
rejected mainly due to presence of heavy-tails in macroeconomic forecast errors. Therefore, using the Student
distribution6 might be preferred against the Gaussian one for fan-chart modelling.’ Supplementary paper by
Harvey & Newbold (2003) strengthens the evidence against the normality of past forecast errors. Utilising
a body of data from the Survey of Professional Forecasters (SPF), Harvey & Newbold (2003) show the
non-normality of macroeconomic forecast errors. Specifically, Harvey & Newbold (2003) show leptokurtosis
as a major feature in their analysis, which categorises the assumption of normality as not credible. As early
as three decades ago, Lahiri & Teigland (1987, p.269) rejected the accepted belief of a normal distribution in
favour of distribution which is ’more peaked and skewed.’ Indeed, Lahiri & Teigland (1987) demonstrate that
non-central split-t distribution fit ex post empirical observations notably well. The main finding of Lahiri &
Teigland (1987) paper is that the distribution is mostly positively skewed in the case of inflation, and the
reverse is found in the case of gross domestic product.
In addition, Rossi & Sekhposyan (2014) assess the predictive densities of output and inflation growth
in the United States through a sizeable macroeconomic data-set predicated on the widely used normality
assumption. Rossi & Sekhposyan (2014, p.662) conclude that ’normality is rejected’ according to at least one
from the broad range of tests utilised. Likewise, Kapetanios et al. (2005) published a study on evaluating
fan-charts in the United Kingdom. They found that both inflation and GDP out-turns emanated from a
different distribution than implied by the fan-chart for long forecast horizons (Kapetanios et al. 2005). In
words:...’that probably reflects out-turns being more concentrated than implied by the width of the fan-charts’
(Kapetanios et al. 2005).
2.1.2 Applications of split-t distribution in other fields of literature
We first discuss the use of a split-t distribution exploited in other application areas than for fan-chart mod-
elling. On the subject of applicability and practical use, the split-t distribution is the most widely used
model for economic and financial modelling (Li & Nadarajah 2020). Perhaps, this is because the flexibil-
ity of a generalised split-t distribution meets the objection that ’parametric models are too restrictive and
6 Here, the Student distribution refers to the split-t distribution.
5
vulnerable to misspecification’ (Harvey & Lange 2015, p.2). Even though there are various generalisations7
of the split-t distribution in literature (see Li & Nadarajah (2020)), the parameterisation8 of Fernández &
Steel (1998) split-t distribution is considered in this paper.
Mittnik & Paolella (2000, p.313) published a study on modelling Asian currency exchange rates in which
the assumption ’crucial for the development and implementation of classic portfolio analysis, namely (...)
normality of returns,’ is drawn into question due to the need to account for the presence for fatter tails and,
in several instances, skewness. Improved in-sample fit is achieved through an asymmetric split-t distribution,
possibly reflecting that the notion of asymmetry allows portfolio managers to capture the downside risk in
financial positions (Mittnik & Paolella 2000). Furthermore, Muteba Mwamba (2012) observed patterns of
skewness in hedge fund’s returns and implemented a split-t distribution to capture investment strategies
allocation for risk-averse individuals. In that case, the preference of risk-averse investors is geared towards
positively skewed portfolios (Muteba Mwamba 2012). This is further confirmed by Scott & Horvath (1980,
p.919) in the following: ’preference for positive skew as an inherent result of risk aversion.’ This observation
provides the basis for the use of a split-t distribution in asset returns applications.
Apart from that, the practicality and flexibility of a split-t distribution appear to be convenient in yet
another branch of literature, particularly in modelling stochastic volatility of the S&P 500 index due to
’asymmetrically heavy-tailed distributions of stock returns’ (Nakajima & Omori 2012, p.3701). In particu-
lar, robust evidence of skewness and the presence of heavy tails are found (Nakajima & Omori 2012). This
observation only justifies the necessity re-consider the use of split-t distribution in other applications, for
example in fan-chart modelling. Additionally, as observed by Mitchell & Weale (2019), Rubio & Steel (2015)
introduce a five-parameter split-t distribution (also called a double two-piece DTP distribution) in which
different shape parameters γ1 , γ2 and different scale parameters σ1 , σ2 are introduced on each side of the
mode ξ. The main advantage of using the DTP model is the ’interpretability of its parameters’ (Rubio
& Steel 2015, p.1903). However, we refrain from the use of Rubio & Steel (2015) distribution due to the
difficulty in parameter estimation, but scholars are invited to investigate this issue further.
Zhu & Galbraith (2010, p.297) notes that Fernández & Steel (1998) introduced a skewness parameter γ,
which resulted in a ’skewed version of the student-t distribution.’ In general, the use of a split-t is applica-
ble in empirical applications with higher leptokurtosis than normal, for example, in insurance applications
(Eling 2012) or financial applications (Zhu & Galbraith 2010). In the area of financial econometrics, Zhu
7 For inferential aspects of the split-t distribution, see also Di Ciccio & Monti (2011).
8 The parameterisation of Fernández & Steel (1998) is also adopted by Mitchell & Weale (2019) to explore its suitability in
terms of model-fitting of past forecast errors in the United Kingdom.
6
& Galbraith (2010) found the use of a split-t distribution for two reasons. First, the relative frequency
of extreme values far exceeds what could be accounted for by a gaussian distribution (Zhu & Galbraith
2010). Second, the equality of relative frequency of extreme returns in left and right tails is often violated
in empirical observations (Zhu & Galbraith 2010). Notably, a skewness parameter γ mainly controls the
distribution’s asymmetry in the central part and not that much in tails (Zhu & Galbraith 2010). Therefore,
Zhu & Galbraith (2010) modifies the split-t distribution and permits the number of degrees of freedom to
differ on each side of the mode. This transformation offers the potential to improve the ability to fit and
forecast empirical data in the tail regions9 (Zhu & Galbraith 2010).
In brief, this section summarises the literature on the choice of a statistical distribution for fan-chart
modelling. Firstly, it presents potential issues with using the split-normal distribution in forecasting applica-
tions. Secondly, it investigates whether some of these issues can be reduced by using the split-t distribution.
In consideration of the above, we explore the parametric framework of the two distributions in the next
section.
9 In the premise that the objective of this paper is not so much to examine the behaviour in tails, we proceed with the
assumption that the number of the degrees of freedom does not vary on each side of the mode.
7
3 Theoretical Framework
The term "forecast uncertainty" is primarily viewed as a quantitative assessment in which the probabilistic
distribution of all possible outcomes is presented through the use of fan-chart (Razi & Loke 2017). Several
central banks10 use fan-charts to represent the forecast uncertainty, among which is the Bank of England,
the Bank of Italy, the Bank of Canada, the Reserve Bank of Australia and the European Central Bank (Rossi
2019). Predictive densities quantifying forecast uncertainty can be generated from parametric models (such
as split-normal or split-t) or in a non-parametric form (see Survey of Professional Forecasters of the Federal
Reserve Bank of Philadelphia) (Rossi 2019).
It is generally acknowledged in the literature that a split-normal distribution is used for fan-chart mod-
elling. However, various methodologies on the construction of fan-charts, particularly in the framework of
parameter estimation, have been proposed in literature (Razi & Loke 2017). The matter of debate concerns:
(i) variance estimation; (ii) asymmetry assessment (Pońsko & Rybaczyk 2016). For example, the Bank of
England provides an asymmetric fan-chart in which variance estimation is based on past forecast errors,
and asymmetry assessment is derived from an analysis of alternative scenarios (Pońsko & Rybaczyk 2016).
Expert judgement in asymmetry and variance assessment is used by central banks in Canada, Norway,
Columbia, the United Kingdom, but not in the Slovak Republic (Pońsko & Rybaczyk 2016). The standard
model-based methodology on the construction of fan-chart, initially developed by John (1982), was advanced
by Österholm (2009) and Elekdag & Kannan (2009). They proposed to include market-based information
on the subject of uncertainty surrounding a modal prediction into model parameters. The Czech National
Bank uses a Bayesian Vector Autoregressive model (BVAR) as a possible enhancement to fan-charts solely
based on historical errors (Franta et al. 2014). Specifically, they allow for incorporating prior information in
the model-based assessment, which may prove helpful for short data time span (Franta et al. 2014).
Bank of England publishes its predictions for inflation and GDP growth every quarter (Kapetanios et al.
2005). In 2013, the Bank also started to publish its predictions for unemployment growth (Mitchell & Weale
2019). Importantly, the member’s judgement is translated into a quantitative assessment of the balance of
risks to a significant degree (Turner & Chalaux 2019). More precisely, the members of the Monetary Policy
Committee consider past forecasts errors as a point of reference in an attempt to determine the width of fan-
chart (Nakamura & Nagae 2008), adjusted thereafter upwards or downwards based on the forward-looking
subjective assessment of the degree of uncertainty (Britton et al. 1998).
Bank of Japan publishes fan-chart in their quarterly Report in which asymmetry assessment of the balance
10 See Ohnsorge et al. (2016) for a literature review on fan-chart construction methodology used by various central banks.
8
of risks to the median forecast is assessed by each Policy Board member (Outlook for economic activity and
prices 2021). Model-based assessment of past forecast error in the form of 50%, 75%, and 90% uncertainty
bands is used by Sveriges Riksbank (the Swedish central bank) (Monetary Policy Report 2020). In India, the
uncertainty assessment is calculated on the basis of the historical standard deviation of the forecast errors,
but subjective assessment is also factored in the model-based estimate (Banerjee & Das 2011). Board of
Governors of the Federal Reserve System published its first model-based fan-chart in their July 2017 Report
in conjunction with histograms of Federal Open Market Committee (FOMC) participants’ assessments of
uncertainty and risk asymmetry around its central projection (Monetary Policy Report 2017). We stress here
that this paper restricts itself to a univariate model-based fan-chart in which the subjective assessment is
not considered.
The remainder of this section is structured as follows. The description of the parameters is provided
in Section 3.1. Parametric framework is addressed in Section 3.2. The method of the maximum likelihood
(ML) utilised to estimate the parameters is discussed in Section 3.3.
3.1 Preliminary Remarks
The split-normal distribution of John (1982), used for the purpose of fan-chart modelling, is defined by the
three parameters: the location parameter ξ as a measure of the central tendency, discussed in 3.1.1; the
scalar shape parameter σ as a measure of the degree of uncertainty to the modal forecast, discussed in 3.1.2;
the parameter γ as an index of skewness, discussed in 3.1.3. The use of the split-normal distribution for
generating probabilistic forecasts of inflation is well recognised in literature11 (Charemza et al. 2015). A fan-
chart is generated once the parameter values up to eight-quarters ahead are specified, based on the assumption
that every such probability density function is defined by the split-normal distribution (Dowd 2007). The
first four future quarters are estimated with the corresponding time lag (Gavura 2009). For example, the
estimation of the parameter value for a standard deviation for the first future quarter is estimated from the
errors of past predictions, which were observed for a period of three months (Gavura 2009). Similarly, the
estimate for the second quarter is computed from the errors of past predictions, which were observed for a
period of six months (Gavura 2009). Finally, the estimates for the remaining four quarters are approximated
by a logarithmic trend (Gavura 2009).
11 See also Wallis (1999).
9
3.1.1 The Central Tendency
The location parameter ξ ∈ R, or the central projection of the most likely path for the variable considered,
represents the mode12 of the split-normal distribution (Britton et al. 1998). The mode parameter is based
on the assumption of constant interest rates (Kapetanios et al. 2005). In addition, the parameter serves as
the basis from which the split-normal distribution is shaped with the width of the distribution on each side
of the mode representing the balance of risks to the modal forecast (Britton et al. 1998, Kapetanios et al.
2005).
3.1.2 The Degree of Uncertainty
Apart from the modal forecast, an inflation-targeting central bank determines a measure of dispersion13 of
the distribution. It is denoted by the parameter σ, which shows the possibility of an alternative outcome
occurring relative to modal forecast. The degree of asymmetry determines the position of the mean relative
to the central tendency (Kapetanios et al. 2005). Further, Britton et al. (1998) states on the issue of the
construction of parameter σ that it can be derived as a weighted sum of all individual variances for each
alternative outcome that is judged to happen as an alternative to the modal forecast. As this is not feasible
in practice, ’past inflation forecast error variance is taken as a starting point and then adjusted upwards or
downwards’ (Britton et al. 1998, p.33). The unknown population variance of the forecast error is proxied
with the in-sample fitted estimated variance (Rossi 2014).
However, the potential issue may be that the past forecast error variance directly depends on the choice of
the statistical distribution used for the purpose of fan-chart modelling, although it is not generally perceived
in such a way in literature. If the split-normal distribution is incorrect, then the width of the distribution
− the balance of risks to the modal forecast − may not be correctly specified, and it may give misleading
results. This is the issue we attempt to investigate in this paper. Dowd (2007) encountered this matter in her
study, although she does not explicitly state that the choice of the distribution is incorrect (see Section 1).
The following statement illustrates this issue: ’...stated that the parameters of the distribution of past forecast
errors are helpful as a means of informing its choices. But if the MPC wishes its choices to be informed by
past forecast errors, how best should we estimate the parameters of the distribution of past forecast errors?’
(Mitchell & Weale 2019). By means of a body of data from the National Bank of the Slovak Republic that is
similar to that of Mitchell & Weale (2019), we draw attention to the width of the distribution in the context
1 yt −µ
12 Gaussian distribution ∼ N (µ, σ 2 ); µ ∈ R, σ ∈ R+ with the probability density function f (yt ) = √1 e− 2 ( σ ) is defined
σ 2π
as one in which the modal value is equal to the mean due to the notion of symmetry. However, the split-normal distribution
considered in this paper, where risks are unbalanced and not symmetrical around the mode, ’the average of all alternative
outcomes is unlikely to be the same as the single most likely case, and the mean forecast will differ from the mode’ (Britton
et al. 1998, p.32).
13 Note that σ 6= σ for a split-normal distribution due to the notion of asymmetry.
1 2
10
of the suitability of a split-normal for fan-chart modelling.
3.1.3 The Balance of Risks
The measure of skewness14 is denoted by the parameter γ, which shows the upside and downside risks to
the modal forecast (Britton et al. 1998). It is calculated as the difference between the mode and the mean15
(Britton et al. 1998). The degree of asymmetry determines the location of the mean (Kapetanios et al. 2005).
For split-normal, the range of the parameter γ is restricted to (−0.9953, 0.9953) in the univariate setting
(Marchenko & Genton 2010). The split-normal distribution allows the magnitude of available skewness to
widen contrary to a gaussian distribution, which does not allow for skewness (Eling 2012). However, this
magnitude of skewness is still restricted (Eling 2012). This issue is alleviated by the use of a more flexible
split-t distribution of Azzalini & Capitanio (2003), which allows for more extreme values for skewness (Eling
2012).
3.2 A Parametric framework
The National Bank of the Slovak Republic uses a split-normal distribution for fan-chart modelling (Gavura
2009), which is a transformation of John (1982), who first proposed this distribution. The parameter
specification of split-t distribution of Fernández & Steel (1998) is utilised throughout the composition of this
section. The probability density function16 of a split-normal distribution is defined as follows:
2 1 (yt − ξ)2
r
f (yt ) = exp − if yt < ξ
π σ1 + σ2 2σ12
(1)
2 1 (yt − ξ)2
r
= exp − if yt ≥ ξ
π σ1 + σ2 2σ22
14 This measure of skewness implicitly relies on the choice of underlying distribution (Mitchell & Weale 2019). Therefore,
the position of mean changes if split-normal is replaced by split-t, which results in a different parameter value for skewness.
Therefore, Arnold & Groeneveld (1995) have suggested defining skewness yM = 1 − 2F (Mx ), where F is the cumulative density
function, which is invariant with the underlying distribution.
15 The mean value represents ’a probability-weighted average across a range of alternative forecasts’ (Britton et al. 1998, p.33).
16 To clarify, the split-normal distribution is a function of the following three parameters f (y ; ξ, σ , σ ) and the split-t
t 1 2
distribution is a function of the following four parameters f (yt ; ξ, σ, γ, υ). The parameter γ regulating symmetry is not included
in Equation 1 but is included in Equation 5. The asymmetry of the split-normal distribution is regulated by Equation 4.
11
The moments of the split-normal distribution are as follows17 :
2
r
µ(yt ) = ξ + (σ2 − σ1 ) (2)
π
2

var(yt ) = 1 − (σ2 − σ1 )2 + σ1 σ2 (3)
π
2 4
r
γ(yt ) = (σ2 − σ1 ) − 1 (σ2 − σ1 ) + σ1 σ2
2
(4)
π π
Based on the possibility of issues with a split-normal for fan-chart modelling, identified in Section 1, I choose
the model as
yt ∼ two piece t-distribution(ξ, σ, γ, υ, n = 53, 57)
Parameter description is discussed in Section 3.1; n = 53, 57 refers to the sample size for the eight- and
four-quarter-ahead forecast errors, respectively. Because the distribution is not symmetric, it is essential to
distinguish between the mode and the mean. For this reason, the mode of the distribution is denoted as ξ.
It should not be confused with µ that denotes the mean of the distribution. The probability density function
of a split-t distribution is defined as follows:
−(υ+1)/2
2 Γ( υ+1 2 ) (yt − ξ)2

f (yt ) = 1 + if yt < ξ
σ(γ + 1/γ) Γ( υ2 )(πυ) 12 γ 2 υσ 2
−(υ+1)/2 (5)
2 Γ( υ+1 2 ) γ 2 (yt − ξ)2

= 1+ if yt ≥ ξ
σ(γ + 1/γ) Γ( υ2 )(πυ) 12 υσ 2
where γ is the scalar skew parameter, υ is the degrees of freedom of the t-distribution, ξ is the location
or the mode, σ is the scale, and Γ(·) is the gamma function.18 The probability on the left of the mode
is calculated as γ 2 /(γ 2 + 1) and on the right of the mode 1/(γ 2 + 1) (Mitchell & Weale 2019). Generally,
a large number of degrees of freedom indicates that the distribution is very close to normal (Mitchell &
Weale 2019). Additionally, a small number of the degrees of freedom indicates that extreme values occur
frequently compared to that of a normal distribution with the same scale parameter (Mitchell & Weale 2019).
Special cases of the split-t distribution are the location-scale t-distribution, obtained when γ = 0, and the
split-normal distribution, obtained when limν→∞ (Di Ciccio & Monti 2011). If both γ = 0 and limν→∞ ,
then the split-t distribution reduces to the gaussian distribution (Di Ciccio & Monti 2011).
17 See John (1982) (equation 2.6) and note that it is used by the National Bank of the Slovak Republic in their Macroeconomic
Predictions Report 17, 7/2009.

18 The parameter specification is adopted from Mitchell & Weale (2019). The scale parameter to the left of the mode is σγ;
to the right of the mode σ/γ (Mitchell & Weale 2019), which shows the dependence between a skew and shape parameter.
12
3.3 Maximum Likelihood Estimation
The split-t distribution is estimated via the method of Maximum Likelihood (ML) and is follows19 :
! T −(υ+1)/2
2 2 )
γ( υ+1 γ 2 (yt − µ)2
X
log L = T ln + I(yt − µ)ln 1 +
σ(γ + 1/γ) γ( υ2 )(πυ) 12 t=1
υσ 2
−(υ+1)/2 (6)
T
(yt − µ)2
X
+ I(µ − yt )ln 1 +
t=1
γ 2 υσ 2
The log-likelihood function is an order of observations yt , with I(y) an indicator function, I(y) = 1 if y ≥ 0
and I(y) = 0 if y < 0 (Mitchell & Weale 2019). The probability density function of the split-t distribution
is defined as:
t
Y
f (y1 |θ) · f (y2 |θ) · ... · f (yt |θ) = f (yt |θ) (7)
i=1
which shows the probability of observing the set of values y1 , y2 , ..., yt given the vector of parameters θM LE .
Mathematically, θM LE = (ξ, σ, γ, ν)T is K × 1 vector of unknown population parameters, defined on a one-
dimensional parameter space, denoted as Θ (Myung 2003); with θ ∈ Θ ⊂ Rk . Because the probability
of observing the set of values given the vector of parameters is identical to the likelihood of the vector of
parameters as being a certain value given the observed set of values, the following must satisfy
n
Y
L(θM LE |yt ) = f (yt |θM LE ) (8)
i=1
The log-form of the likelihood function
n
X
ln L(θM LE |yt ) = lnf (yt |θM LE ) (9)
i=1
represents the likelihood of the parameter vector θM LE given the observed data yt (Myung 2003) and is
maximised20 when
θ̂M LE = argmax L(θM LE |yt ) (10)
γ,σ∈R+ ,ξ∈R
If the log-likelihood function ln L(θM LE |yt ) is differentiable, then it must satisfy the following (Myung 2003):
∂ln L(θM LE |yt )

=0 (11)
∂θM LE
∂ 2 ln L(θM LE |yt )
2 <0 (12)
∂θM LE
19 Note that equation 6 is adopted from Mitchell & Weale (2019); see p.11.
20 sn package from Azzalini (2020) is used for the purpose of fan-chart modelling in R environment. It is available at
http://azzalini.stat.unipd.it/SN/.
13
The assumption of independent and identically distributed (i.i.d.) forecast errors is maintained for all horizon
periods considered here. However, forecast errors’ independence should not be expected in applications where
the forecast horizon is greater than one-step-ahead (Mitchell & Weale 2019).
3.4 Likelihood Ratio test
Adding a parameter to the model will almost always make the model fit better (log-likelihood closer to zero
or less negative) (FAQ: How are the likelihood ratio, Wald, and Lagrange multiplier (score) tests different
and/or similar? n.d.). However, it is essential to test whether this difference is statistically significant (FAQ:
How are the likelihood ratio, Wald, and Lagrange multiplier (score) tests different and/or similar? n.d.). If
the difference is statistically significant, then the less restrictive model (the model with more parameters)
is observed to fit the empirical data better than the more restrictive model (FAQ: How are the likelihood
ratio, Wald, and Lagrange multiplier (score) tests different and/or similar? n.d.). The likelihood ratio test
statistic is expressed mathematically as
L(θˆ0 |yt )
ΛLR = (13)
L(θˆ1 |yt )
where L is the logarithm of the likelihood function. As in Ning & Ngunkeng (2013), we test the following
hypothesis:
ˆ σˆ1 , σˆ2 ) = θˆ0
H0 : f = f0 ∼ yt (ξ,
ˆ σ̂, γ̂, ν̂) = θˆ1

H1 : f = f1 ∼ yt (ξ,
where under the null hypothesis yt follows a split-normal distribution over a parameter space θˆ0 = (ξ,
ˆ σˆ1 , σˆ2 )
(Ning & Ngunkeng 2013). The alternative hypothesis is that the model follows a split-t distribution. The
decision rule is stated as follows:
if ΛLR > α, do not reject H0 ;
if ΛLR < α, reject H0 ;
where the significance level α = 0.05.
14
4 Empirical Strategy
This section describes the methodological approach for this paper. Data summary is discussed in Section
4.1. The estimation procedure of the model parameters is discussed in Section 3.3 and the resulting values
are presented in Section 4.2. The procedure of fitting two parametric densities to forecast error data is also
discussed. The discussion of the results is deferred until Section 5. Finally, the interpretation of the results
is presented in Section 5.1 and imitations of this paper are discussed in Section 5.2.
4.1 Data Summary
The data-set spanning the period 2007q2 - 2018q3 is used in this paper. We focus on the eight-quarter-
ahead forecast errors in the main paper, given that it is an established practice in the literature on fan-chart
modelling. We also provide the analysis of the four-quarter-ahead forecast errors for comparison purposes in
Section A of the Appendix. The number of observations (n = 53 for the eight-quarter-ahead forecast errors
and n = 57 for the four-quarter-ahead forecast errors) is considered as ’appropriate’ in the literature; hence
it does not prevent us from parameter estimation (Azzalini 2020, 56). The National Bank of the Slovak
Republic began to publish its Medium Term Forecast in 2005q2. Therefore, 2007q2 (eight quarters ahead)
is used as the point of departure in our data-set. The 2020q3 is the vintage of data out-turns because it is
taken at the time of writing this paper.
Data come from the National Bank of the Slovak Republic Macroeconomic Database due to ease of access
and public availability. It is a balanced panel of data with no missing values observed. The National Bank of
the Slovak Republic publishes forecasts for inflation and GDP for up to twelve quarters ahead; with rates of
change defined over four quarters21 (Mitchell & Weale 2019). The forecast errors are compared to the modal
forecast provided by the National Bank of the Slovak Republic. The extreme values are not excluded from
the data-set22 . Data out-turns are cross-checked with those published by the Statistical Office of the Slovak
Republic to ensure its validity. Dates correspond to the out-turn’s date (for example, 2007q2 refers to the
out-turn’s date; it does not refer to the date at which the forecast is made). Data out-turns are compared
for both eight- and four-quarter-ahead predictions.
21 The National Bank of the Slovak Republic changed its publication model in 2013q1 and began to publish quarterly forecasts
in Medium Term Forecast for four, eight, and twelve periods ahead. Before 2013q1, the Bank had published only yearly forecasts.
Therefore, the predictions from 2007q2 - 2012q4 are considered as for that specific quarter eight quarters ahead.
22 See the left tail of Figure 2. The National Bank of the Slovak Republic predicted a 4% GDP growth in 2018q2. However,
the subsequent out-turn was −12.11% due to COVID-19. As a result, the forecast error was −16.11%.
15
4.2 Application to the Forecast Error Data
The forecast error is defined as out-turn minus forecast so that negative errors are out-turns below forecast
(Mitchell & Weale 2019). Figure 1 and Figure 2 are estimated on the basis of all available data from 2007q2
- 2018q3. Inflation and GDP growth are measured using the 2020q3 vintage data series (Galbraith & Norden
2012). Figure 1 and Figure 2 present a visual representation of split-normal and split-t distribution fitted23
to forecast error data. We show the forecast error histogram for inflation predictions in Figure 1. The
corresponding forecast error histogram for GDP predictions is shown in Figure 2. Three distributions are
plotted against the forecast error histogram. Particularly, a univariate pdf f (·) of parametric split-normal
and split-t distribution is showed in Figure 1 and Figure 2 in conjunction with non-parametric empirical
density curve. The parameter specification24 of the split-t distribution for inflation and GDP growth follows
from Fernández & Steel (1998). Similarly, the parameter specification of the split-normal distribution is
adopted from John (1982) because it is an established practice in the literature on fan-chart modelling.
Table 1 and 2 show the parameter values estimated via the method of maximum likelihood for the eight-
and four-quarter-ahead forecast error data, respectively. The log-likelihood and the Akaike Information
Criterion (AIC) are provided. The plotted densities for the eight-quarter-ahead projections are shown in
Section 5. For space reasons, plotted densities for the four-quarter-ahead projections are included in Section
A of the Appendix.
23 A supplementary material is provided in Section A of the Appendix.

24 The parameterisation of Fernández & Steel (1998) for split-t distribution is also adopted in Mitchell & Weale (2019).
16
Table 1: Parameter Estimates for Split-Normal and Split-t densities for Inflation and GDP fitted to eight-
quarter-ahead Forecast Error Data
Inflation:2007q2 - 2018q3
Distribution Log-likelihood AIC ξˆ σ̂ γ̂ υ̂
2PN -95.0223 196.0446 -0.9761 1.4850 0.5069
2Pt -95.0036 199.9278 -0.8067 1.4991 0.4675 1.2720
GDP:2007q2 - 2018q3
2PN -146.9794 299.9589 -0.6051 4.0376 -0.6326
2Pt -140.0775 288.1551 -0.7621 2.5841 -0.8734 4.5282
Table 2: Parameter Estimates for Split-Normal and Split-t densities for Inflation and GDP fitted to four-
quarter-ahead Forecast Error Data
Inflation:2007q2 - 2018q3
2PN -99.2713 204.5426 -0.5387 1.3957 0.3734
2Pt -98.3902 204.7805 -0.6164 1.4770 1.3190 10.4890
GDP:2007q2 - 2018q3
2PN -157.5699 321.1398 0.6183 4.0620 -0.7168
2Pt -154.1279 316.2558 0.0462 3.2266 -0.8079 3.0644
17
The results in Table 1 and 2 are estimated utilising the original data (Eling 2012). Log-data are not
considered (Eling 2012). The estimated parameters are denoted by subscript n and t, for split-normal and
split-t distribution, respectively. Additionally, the number next to the lower script shows whether the pa-
rameter value was estimated using eight- or four-quarter-ahead forecast error data. The upper script i, g
is adopted for comparison purposes for inflation and GDP forecast errors, respectively. The resulting pa-
rameter estimates are first examined25 for inflation before directing attention to the GDP forecast error data.
For split-normal distribution, Table 1 returns the following parameter values for the eight-quarter-ahead
inflation forecast error data. The location parameter (the mode) of the univariate split-normal ellipti-
cally contoured distribution is ξn,8
i
= −0.9761, scale parameter σn,8
i
= 1.4850, and slant scalar parameter
i
γn,8 = 0.5069. For split-t distribution, Table 1 returns the following: the location parameter of the univari-
ate split-t elliptically contoured distribution is ξt,8
i
= −0.8067, scale parameter σt,8
i
= 1.4991, slant scalar
parameter γt,8
i
= 0.4675, and the number of degrees of freedom νt,8
i
= 1.2720.
Given that the split-normal distribution is routinely used for fan-chart modelling, it is the benchmark
against which the split-t distribution is compared. The Akaike Information Criteria (AIC) and the likelihood
ratio test are used for this purpose. Table 1 show that the parameter value for the mode is lower in the case
of the split-t distribution for the eight-quarters-ahead inflation forecast errors. However, the reverse is true
for the four-quarters-ahead (see Table 2). For the two horizon periods, the split-t distribution suggests a
higher parameter value for the standard deviation. For inflation, both the split-normal and split-t suggest a
positive skewness for the two horizon periods considered in this paper. The degrees of freedom for the eight-
and four-quarters-ahead are at 1.2720 and 10.4890, respectively.
The parameter estimates of the split-normal distribution for the eight-quarter-ahead GDP forecast error
data are as follows: the location parameter of the univariate split-normal elliptically contoured distribution
g g g
is ξn,8 = −0.6051, scale parameter σn,8 = 4.0376, and slant scalar parameter γn,8 = −0.6326. For split-t
distribution, Table 1 returns the following: the location parameter of the univariate split-t elliptically con-
g g g
toured distribution is ξt,8 = −0.7621, scale parameter σt,8 = 2.5841, slant scalar parameter γt,8 = −0.8734,
g
and the number of degrees of freedom νt,8 = 4.5282.
Interestingly, the mode parameter is in the range of negative values for the eight-quarter-ahead GDP
forecast error data. However, it is in the range of positive values for the four-quarter-ahead errors. The
findings for the standard deviation appear to be consistent across the two horizon periods. In particular,
25 Note that we defer the discussion of the results until Section 5.
18
the split-t distribution suggests a lower value for the balance of risks to the modal forecast compared to
the split-normal distribution. It is noteworthy that while the estimated skewness parameter is consistently
positive for inflation forecast errors, it is consistently negative for GDP. Both the split-normal distribution
and the split-t distribution confirm this result for the two horizon periods under consideration. Despite
the consistent direction for skewness, the magnitude varies. For example, the split-t distribution suggests a
greater left-skew for both horizon periods than the split-normal.
On the basis of the above, we discuss the results and interpret our findings in the next section. We also
explore whether our findings are consistent with the literature on fan-chart modelling.
19
5 Results
This section concerns the analysis of the empirical findings in Section 4 through the lens of the research
question:
Is forecast errors better26 represented by a split-t distribution rather than a split-normal?
5.1 Interpretation
We divide this section as follows. In part (i), we begin the discussion by analysing the balance of risks to
the modal prediction. In part (ii), we shift our attention to discuss the forecast error bias. In part (iii), we
continue the discussion by comparing the degree of uncertainty between the two parametric distributions.
In part (iv), we conclude our analysis by checking for robustness.
As concerns part (i), the parameter γ in equations 4 and 5 quantifies the skewness of the underlying
distribution (see Section 3). In this way, researchers obtain a sense of balance of risks to the central pre-
diction. It should be emphasised here that if γ > 0, then a probability density function is skewed towards
higher values of a variable of interest; if γ < 0, then the probability density function is skewed towards lower
values of a variable of interest (Dowd 2007, Eling 2012). An initial visual impression from Figure 1 hints
that the two parametric distributions fitted to 2007q2 - 2018q3 forecast error data for inflation are close to
being symmetric. However, a further examination rejects the early visual apprehension and indicates that
the forecast errors for inflation are slightly right-skewed. In particular, the eight-quarter-ahead predictions
were below the subsequent out-turn, on average.
Quantitatively, a standard measure of skewness in the literature is calculated as the difference between
the mode and the mean27 (Britton et al. 1998). The mean of the split-normal is −0.5317 and the mode is
−0.9761 for the eight-quarter-ahead inflation forecast error data. Similarly, the mean of the split-t is −0.5536
and the mode is −0.8067. Because the mean is above the mode for split-normal and split-t distribution,
the inflation forecast error data is right-skewed. Furthermore, the maximum likelihood method returns a
positive value for skewness in inflation predictions for the two parametric distributions. Table 1 shows that
the split-t distribution suggests less skew to the right than does split-normal (γ̂ = 0.5069 for split-normal
compared to γ̂ = 0.4675 for split-t).
26 The word "better" is a qualitative comparative measure. In quantitative terms, the Akaike Information Criteria (AIC) and
the likelihood ratio test are used to investigate whether the split-t distribution is superior to the split-normal distribution for
fan-chart modelling.
27 ’The mean of the distribution is the probability-weighted average across a range of alternative forecasts’ (Britton et al. 1998,
p.33). The mode is simply the central projection or the single most likely path (Kapetanios et al. 2005). The balance of risks
is measured as the difference between the mean and the mode of the forecast (Britton et al. 1998). However, the counterpart
of this is that the mean implicitly depends on the choice of the underlying distribution.
20
On the contrary, the result for skewness, or the balance of risks, is reversed for GDP forecast error data.
A visual impression from Figure 1 confirms that the left tail appears to be heavier than the right tail. Indeed,
the projections for both periods under consideration were above the subsequent out-turn, on average. Table
1 and 2 give negative values for skewness for the two parametric distributions, with split-t indicating a more
significant skew to the left. In particular, Table 1 shows that γ̂ = −0.6326 for split-normal distribution
compared to γ̂ = −0.8734 for split-t distribution. The result for left-skew is also confirmed by exploring the
location of the mean and the mode. Specifically, the mean of the split-normal is −2.2275, and the mode is
−0.6051 for GDP forecast error data. Similarly, the mean of the split-t is −1.4037, and the mode is −0.7621.
Given that the mean is below28 the mode for split-normal and split-t distribution, the GDP forecast error
data is left-skewed.
Additionally, the need for differentiating upside and downside risks to the modal forecast is emphasised
in Adrian et al. (2019). Specifically, the estimated split-t distribution shows a robust time-series variation
in the left tail, while the distribution inherits the stability in the right tail (Adrian et al. 2019). A similar
finding is observed in this paper (see the left tail of Figure 2). We end the comparison of the balance of risks
to note that an identical result was reached by Mitchell & Weale (2019). Mainly, the inflation forecast error
data are right-skewed, and GDP forecast error data are left-skewed.
In part (ii), we shift the discussion to the implications of the two parametric distributions for the forecast
error bias. In general, the forecast errors should be unbiased regardless of the size of the errors (Dobbelaere
& Lebrun 2012). They should not be persistently too optimistic or too pessimistic, which implies that the
positive and negative forecast errors should offset each other, on average (Dobbelaere & Lebrun 2012). Be-
cause the split-normal and the split-t distribution are not symmetric, we focus on the modal forecast error
bias (reflected in parameter ξ) rather than the mean forecast error. Table 1 shows that split-t distribution
indicates less29 forecast error bias compared to split-normal for the eight-quarter-ahead inflation predictions.
Precisely, Table 1 returns a value of parameter ξˆ = −0.9761 for split-normal compared to ξˆ = −0.8067 for
split-t. However, the opposite occurs for the eight-quarter-ahead GDP projections. In particular, the split-t
distribution suggests a greater30 forecast error bias than the split-normal distribution.
28 In this instance, ’below’ is equivalent to more negative.

29 Less forecast error bias is reflected in a lower value for parameter ξ̂ (Mitchell & Weale 2019).
30 Interestingly, Mitchell & Weale (2019) find that the bias falls from ξ̂ = 0.9 to ξ̂ = 0.03 for GDP predictions when using the
split-t rather than the split-normal. We observe a similar result for the four-quarter-ahead GDP predictions, with ξ̂ dropping
from 0.61 to 0.04 when using the split-t (see Table 2).
21
In part (iii), we shift the discussion by focusing on the dispersion of uncertainty around the central pre-
diction. Then, we compare the results between the two parametric distributions. Firstly, a notable aspect
is observed in Figure 2 that fits the densities to the GDP forecast error data. Surprisingly, the probability
mass in the centre of the distribution is not captured well using split-normal distribution. In particular, the
split-normal distribution severely underestimates the probability mass in the centre of the distribution31 .
This issue is alleviated when the split-t distribution is fitted to our data-set.
Contrary to Mitchell & Weale (2019), we are unable to reach a similar conclusion for the eight-quarter-
ahead inflation predictions. The split-t distribution with low degrees of freedom (υ̂ = 1.2720) understates
the probability mass in the centre of the distribution (see Figure 1). The complement of this is that split-t
appears to accommodate the extreme values on the right of the mode. Despite of this, the AIC does not
select the split-t distribution as the preferred model. This result is confirmed by the likelihood ratio test
with p-value = 0.1700. The null hypothesis is not rejected at the 5% significance level. Hence, there is no
evidence capturing fat tails through the split-t improves fit in Figure 1. In summary, Table 1 confirms a
visual impression from Figure 1 that split-normal is preferable32 in terms of model-fitting. Interestingly, the
split-t distribution gives a lower standard deviation than the split-normal for both eight- and four-quarter-
ahead GDP error data. Hence, the risks to the modal forecast are lower if the split-t distribution is used.
However, this result is reversed for the inflation error data as the split-t gives a higher standard deviation
for both horizon periods under consideration.
In part (iv), we compare the in-sample fit of the two parametric distributions. As in Rubio & Steel
(2015) and Mitchell & Weale (2019), we do so through classical information criterion (AIC) based on the
maximum likelihood estimates. Table 1 and 2 show that the Akaike Information Criterion does not select the
split-t distribution as superior in model-fitting for the eight- and four-quarter-ahead inflation forecast errors,
respectively. The null hypothesis33 cannot be rejected for both horizon periods under consideration at a 5%
significance level for inflation predictions (likelihood ratio test p-value = 0.1700, 0.1844 for the eight- and
four-quarter-ahead inflation predictions, respectively). Therefore, the results shows that the split-t distri-
bution does not improve the goodness of fit compared to the split-normal distribution for inflation predictions.
31 Interestingly, Mitchell & Weale (2019) examine the data from the Bank of England and find a similar conclusion. In
particular, Mitchell & Weale (2019) found that the split-normal distribution underestimates the central part of the histogram
of the forecast errors for both variables of interest (inflation and GDP forecasts).
32 Even though the AIC and the likelihood ratio test select the split-normal distribution as the preferred model for the
eight-quarter-ahead inflation predictions, figure 1 also shows that split-normal distribution quite markedly underestimates the
empirical distribution in the right tail.
33 See Section 3.4 for the null and alternative hypothesis.
22
On the contrary, Table 1 and 2 show that the Akaike Information Criterion (AIC) selects the split-t
distribution for the eight- and four-quarter-ahead GDP forecast errors, respectively. Even though the AIC
prefers the model with fewer parameters in terms of model-fitting, it still prefers split-t for GDP forecast
error data. The null hypothesis is rejected at 5% significance level for both eight- and four-quarter-ahead
GDP forecast errors (see Figures 2 and A.6 for the respective p-values).
23
Figure 1: Inflation growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and Split-t
densities fitted to eight-quarter-ahead forecast error data from 2007q2 - 2018q3
30.0%
27.5%
25.0%
22.5%
20.0%
17.5%
Legend
2PN
15.0%
2Pt
Empirical
12.5%
10.0%
7.5%
5.0%
2.5%
0.0%
−10 −8 −6 −4 −2 0 2 4 6 8 10
Note: The bars show the frequency distribution of eight-quarter-ahead past forecast errors of inflation based on body
of data from the National Bank of the Slovak Republic. Solid red line shows a parametric split-normal distribution
(2PN) with scalar ξˆ = −0.9761, σ̂ = 1.4850, γ̂ = 0.5069; solid blue line shows a parametric split-t distribution (2Pt)
with ξˆ = −0.8067, σ̂ = 1.4991, γ̂ = 0.4675, υ̂ = 1.2720. 53 obs used. Dashed black line shows non-parametric density
estimate. Likelihood ratio test p-value 0.1700.
24
Figure 2: GDP growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and Split-t
densities fitted to eight-quarter-ahead forecast error data from 2007q2 - 2018q3
17.5%
15.0%
12.5%
Legend
10.0%
2PN
2Pt
Empirical
7.5%
5.0%
2.5%
0.0%
−20 −16 −12 −8 −4 0 4 8 12 16 20
Note: The bars show the frequency distribution of eight-quarter-ahead past forecast errors of GDP based on body
(2PN) with scalar ξˆ = −0.6051, σ̂ = 4.0376, γ̂ = −0.6326; solid blue line shows a parametric split-t distribution
(2Pt) with ξˆ = −0.7621, σ̂ = 2.5841, γ̂ = −0.8734, υ̂ = 4.5282. 53 obs used. Dashed black line shows non-parametric
density estimate. Likelihood ratio test p-value 0.0002029.
25
5.2 Limitations
The findings of this paper must be accepted through the lens of its limitations considered here. The sample
size is moderate (n = 53, 57 for the eight- and four-quarter-ahead forecast errors, respectively), which is con-
sidered as ’appropriate’ for such analysis (Azzalini 2020, p.56). This paper does not consider the possibility
of structural breaks in density forecasts (Giacomini & Rossi 2015). For example, forecast error distribution
was tighter during the Great Moderation period 1984 due to low volatility (Giacomini & Rossi 2015). It
became more spread out during the 2008 financial crisis, which provides a basis for instabilities in density
forecasts with a warning that all aspects of the underlying forecast error distribution may be time-varying
(Giacomini & Rossi 2015). Indeed, the issue that arises from including time-series data from the 2008 fi-
nancial crisis in this paper is the use of constant variance in parameter estimation. It could be problematic
because ’estimating models with constant variance would clearly lead to misspecification in the uncertainty
in the forecast density’ (Giacomini & Rossi 2015, p.20).
Furthermore, we restricted our analysis to parametric modelling utilising univariate distributions. The
objective is to analyse two primary variables of interest − inflation and GDP − with a single fixed parameter
γ̂, ν̂ which denotes the skewness and number of the degrees of freedom, respectively. The parameter esti-
mation procedure may become problematic due to the fat tails’ presence (see Figure 1 and 2). This issue is
reflected in the fact that a single fixed parameter γ̂ mainly controls the asymmetry (balance of risks around
modal forecast) in the central part of the distribution (Zhu & Galbraith 2010) and not so much in tails. Still,
we invite scholars to consider this issue further and expand on the analysis presented here by adding two
tail parameters γ1 , γ2 in the spirit of Zhu & Galbraith (2010). However, such an application goes beyond
the scope of this paper.
Lastly, the assumption of independently and identically distributed (i.i.d. thereafter) forecast errors over
the period under consideration is essential for forecast efficiency (Kapetanios et al. 2005). However, the i.i.d.
assumption may not be consistent with the data as fan-charts overlap34 (Kapetanios et al. 2005). Therefore,
Kapetanios et al. (2005) advises that unless the i.i.d. assumption is factored in the model, it is not wise to
draw strong conclusions. Indeed, statistical inferences based on strong assumptions [the i.i.d. assumption
considered here] can be subject to severe disagreements, while the ones based on weak assumptions can
achieve wide consensus (Manski 2018).
Based on the above, the extrapolation of the findings is restricted. Notwithstanding the limitations, this
paper offers valuable insights into the field of fan-chart modelling. For example, it emphasises the need to
34 In particular, two projections for eight-quarters-ahead are made one quarter apart (Kapetanios et al. 2005). The predictions
are tested against the same outturns, giving rise to a serial correlation issue (Kapetanios et al. 2005).
26
recurrently question the use of a statistical distribution underlying the forecast error.
27
6 Concluding remarks
This paper discusses a much-neglected issue on fan-chart modelling, namely the assumption of a distribution
underlying past forecast errors. Based on the fact that the parameters of the distribution of past forecast
errors, discussed in 3.1, are helpful for policy-makers to make the prediction (Mitchell & Weale 2019), it is
essential to understand the distributional properties of past forecast errors (Harvey & Newbold 2003). As
stated in Section 2, scholars and academics did not challenge the assumption of a split-normal distribution
for fan-chart modelling since 1998. It was when the split-normal distribution was suggested by Britton
et al. (1998) as a suitable candidate due to its defining characteristic to capture the notion of asymmetry -
the balance of risks on each side of the consensus forecast. However, the following argument: ’Choosing a
particular form for the distribution does not rule out the possibility of changing that choice between Reports’
(Britton et al. 1998, p.32) has not received much attention. Instead, most of the assessment on fan-chart
modelling in literature rests on the assumption of the split-normal distribution at its core Kapetanios et al.
(2005). Consequently, performance tests for these predictive densities are derived after that, such as the
integral probability transform - PITs (see Kapetanios et al. (2005).
To reinstate this paper’s objective, we attempted to answer the question, established in Section 1, Is
forecast errors better represented by a split-t distribution rather than a split-normal?. As shown in Section
5, we reject the null hypothesis for inflation predictions. The Akaike Information Criterion (AIC) does not
select split-t as superior to split-normal in model-fitting, and the following likelihood ratio test confirms this
result. However, we provide adequate evidence that the split-t distribution gives a better in-sample fit for
the GDP forecast error data than the split-normal distribution. Therefore, this paper’s conclusion is twofold:
the split-t distribution is superior in model-fitting for GDP forecast error data, but not for inflation forecast
errors. This result is consistent for the eight- and four-quarter-ahead predictions for both variables of interest.
Some promising avenues for future research are offered. Because predictive density models are contingent
upon instabilities in both parameters and performance over some time (Giacomini & Rossi 2015), a further
study may consider dealing with instabilities. Such analysis can be performed in the spirit of Billio et al.
(2013) who use time-varying weights for parameter estimation. Additionally, if the debate presented in this
paper is to be moved forward, a better understanding of the skewness parameter is needed. In summary,
this paper discusses an essential aspect of fan-chart modelling. Rather than evaluating the performance of
density forecasts through probability integral transforms (PITs), as in standard in literature on predictive
density forecasts (see Berkowitz (2001)), we place more emphasis on the assumption of the distribution
underlying past forecast errors. Specifically, we attempt to conclude whether it is sensible for the National
Bank of the Slovak Republic to abandon the split-normal and replace it with a split-t distribution. We hope
28
that the ideas presented in this paper will be valuable for the researchers at the National Bank of the Slovak
Republic. Not only that, we call for researchers to consider the thoughts presented here and implement them
in any way possible.
29
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A Appendix
A.1 Inflation growth
Figure A.1: Inflation growth: Forecast Error Histogram and Split-Normal
Note: Upper left figure shows the boxplot of observed values. Upper right figure shows the split-normal density fitted
to forecast error data. Bottom figures show the corresponding Q-Q and P-P plots.
Figure A.2: Inflation growth: Forecast Error Histogram and Split-t
Note: Upper left figure shows the boxplot of observed values. Upper right figure shows the split-t density fitted to
forecast error data. Bottom figures show the corresponding Q-Q and P-P plots.
i
A.2 GDP growth
Figure A.3: GDP growth: Forecast Error Histogram and Split-Normal
Note: Upper left figure shows the boxplot of observed values. Upper right figure shows the split-normal density fitted
to forecast error data. Bottom figures show the corresponding Q-Q and P-P plots.
Figure A.4: GDP growth: Forecast Error Histogram and Split-t
Note: Upper left figure shows the boxplot of observed values. Upper right figure shows the split-t density fitted to
forecast error data. Bottom figures show the corresponding Q-Q and P-P plots.
ii
Figure A.5: Inflation growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and
Split-t densities fitted to four-quarter-ahead forecast error data from 2007q2 - 2018q3
35.0%
32.5%
30.0%
27.5%
25.0%
22.5%
20.0%
Legend
17.5% 2PN
2Pt
15.0% Empirical
12.5%
10.0%
7.5%
5.0%
2.5%
0.0%
−10 −8 −6 −4 −2 0 2 4 6 8 10
Note: The bars show the frequency distribution of four-quarter-ahead past forecast errors of inflation based on body
(2PN) with scalar ξˆ = −0.5387, σ̂ = 1.3957, γ̂ = 0.3734; solid blue line shows a parametric split-t distribution (2Pt)
with ξˆ = −0.6164, σ̂ = 1.477, γ̂ = 1.319, υ̂ = 10.489. 57 obs used. Dashed black line shows non-parametric density
iii
Figure A.6: GDP growth (Latest Release Outturns): Forecast Error Histogram and Split-Normal and Split-t
densities fitted to four-quarter-ahead forecast error data from 2007q2 - 2018q3
15.0%
12.5%
10.0%
Legend
2PN
2Pt
7.5% Empirical
5.0%
2.5%
0.0%
−20 −18 −16 −14 −12 −10 −8 −6 −4 −2 0 2 4 6 8 10 12 14 16 18 20
Note: The bars show the frequency distribution of four-quarter-ahead past forecast errors of inflation based on body
(2PN) with scalar ξˆ = 0.6183, σ̂ = 4.0620, γ̂ = −0.7168; solid blue line shows a parametric split-t distribution (2Pt)
with ξˆ = 0.0462, σ̂ = 3.2266, γ̂ = −0.8079, υ̂ = 3.0644. 57 obs used. Dashed black line shows non-parametric density
iv
Example of the code used to generate the Figure A.5 (modelled in R)
data <− data . frame ( data )

c e n t r a l_tendency_dsn <− −0.5387
d i s p e r s i o n_dsn <− 1 . 3 9 5 7
s k e w n e s s_dsn <− 0 . 3 7 3 4
c e n t r a l_tendency_d s t <− −0.6164424
d i s p e r s i o n_d s t <− 1 . 4 7 7
s k e w n e s s_d s t <− 1 . 3 1 9
d e g r e e s_freedom_d s t <− 1 0 . 4 8 9
g g p l o t ( data=data_f o u r , a e s ( x=i n f l a t i o n e r r o r ))+
stat_b i n ( a e s ( y = . . density . . ) , geom=" s t e p " , b i n w i d t h =1, s i z e =0.1 ,
c o l o u r=" b l a c k " ) +
geom_l i n e ( a e s ( y = . . density . . , c o l o r = " E m p i r i c a l " , l i n e t y p e = " E m p i r i c a l " ) ,
stat = ’ d e n s i t y ’ , s i z e =0.2)+
ggtitle ("") +
theme_t u f t e ( t i c k s = FALSE) +
s c a l e_y_c o n t i n u o u s ( b r e a k s = seq ( 0 , 0 . 3 5 , 0 . 0 2 5 ) , l a b e l s = s c a l e s : : p e r c e n t ) +
s c a l e_x_c o n t i n u o u s ( l i m i t s=c ( −10 , 1 0 ) , b r e a k s = seq ( −10 ,10 ,2))+
s c a l e_c o l o u r_manual (
v a l u e s = c ( " E m p i r i c a l "=" b l a c k " , " 2PN"=" r e d " , " 2Pt "=" b l u e " ))+
s c a l e_l i n e t y p e_manual (
v a l u e s = c ( " E m p i r i c a l "=" dashed " , " 2PN"=" s o l i d " , " 2Pt "=" s o l i d " ))+
theme ( legend . key . s i z e = u n i t ( 0 . 5 , ’cm ’ ))+
g u i d e s ( c o l o r = g u i d e_legend ( t i t l e=" Legend " ) ,
l i n e t y p e = g u i d e_legend ( t i t l e=" Legend " ))+
l a b s ( x = " " , y = " " )+
stat_function ( fun = dsn , n=1000 , s i z e =0.4 ,
args = l i s t ( x i = c e n t r a l_tendency_dsn ,
omega = d i s p e r s i o n_dsn ,
a l p h a = s k e w n e s s_dsn ) ,
a e s ( c o l o r = " 2PN" , l i n e t y p e = " 2PN" ))+
stat_function ( fun = dst , n=1000 , s i z e =0.4 ,
args = l i s t ( x i=c e n t r a l_tendency_dst ,
omega=d i s p e r s i o n_dst ,
v
a l p h a=s k e w n e s s_dst ,
nu = d e g r e e s_freedom_d s t ) ,
a e s ( c o l o r = " 2Pt " , l i n e t y p e = " 2Pt " ) )
vi

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Distributional Properties of Forecast Errors for Inflation and GDP:

Lessons from the National Bank of the Slovak Republic

Key words: Forecast uncertainty; Skewed densities; Fan-charts; Model-fitting errors

’One message is clear, however: it is dangerous to look at the pattern of model

2.1 Research methods

2.1.1 Split-normal distribution in fan-chart modelling

2.1.2 Applications of split-t distribution in other fields of literature

3.1 Preliminary Remarks

3.1.1 The Central Tendency

3.1.2 The Degree of Uncertainty

of the suitability of a split-normal for fan-chart modelling.

3.1.3 The Balance of Risks

3.2 A Parametric framework

The moments of the split-normal distribution are as follows17 :

Predictions Report 17, 7/2009.

3.3 Maximum Likelihood Estimation

The log-form of the likelihood function

∂ln L(θM LE |yt )

3.4 Likelihood Ratio test

ˆ σ̂, γ̂, ν̂) = θˆ1

if ΛLR < α, reject H0 ;

where the significance level α = 0.05.

4.1 Data Summary

4.2 Application to the Forecast Error Data

23 A supplementary material is provided in Section A of the Appendix.

Is forecast errors better26 represented by a split-t distribution rather than a split-normal?

28 In this instance, ’below’ is equivalent to more negative.

−20 −16 −12 −8 −4 0 4 8 12 16 20

Henze, N. (1986), ‘A Probabilistic Representation of the "Skew-Normal" Distribution’, Scandinavian Journal

Monetary Policy Report (2020), Stockholm: Sveriges Riksbank November.

Myung, I. J. (2003), ‘Tutorial on Maximum Likelihood Estimation’, Journal of Mathematical Psychology

Österholm, P. (2009), ‘Incorporating Judgement in Fan Charts’, Scandinavian Journal of Economics

A.1 Inflation growth

Figure A.1: Inflation growth: Forecast Error Histogram and Split-Normal

Figure A.2: Inflation growth: Forecast Error Histogram and Split-t

A.2 GDP growth

Figure A.3: GDP growth: Forecast Error Histogram and Split-Normal

Figure A.4: GDP growth: Forecast Error Histogram and Split-t

−20 −18 −16 −14 −12 −10 −8 −6 −4 −2 0 2 4 6 8 10 12 14 16 18 20

Example of the code used to generate the Figure A.5 (modelled in R)

data <− data . frame ( data )

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