On the Aggregation of Probability Assessments: Regularized Mixtures of Predictive Densities for Eurozone Inflation and Real Interest Rates

TL;DR

This paper introduces regularized mixture methods for combining density forecasts, demonstrating improved Eurozone inflation and interest rate predictions by adjusting for overconfidence and emphasizing tail risks.

Contribution

It develops novel regularization techniques for density forecast aggregation and applies them to Eurozone inflation and interest rate data, outperforming individual forecasters.

Findings

Regularized mixtures outperform individual forecasts.

Optimal regularization shifts probability mass to the tails.

Methods correct for overconfidence in density forecasts.

Abstract

We propose methods for constructing regularized mixtures of density forecasts. We explore a variety of objectives and regularization penalties, and we use them in a substantive exploration of Eurozone inflation and real interest rate density forecasts. All individual inflation forecasters (even the ex post best forecaster) are outperformed by our regularized mixtures. From the Great Recession onward, the optimal regularization tends to move density forecasts' probability mass from the centers to the tails, correcting for overconfidence.