Thursday, April 19, 2007

Forecasting the Forecast

Who will forecast the forecasters? Now we know, at least when it comes to the weather. From this week's Economist:
How to forecast the forecasters

IF YOU think the weather is unpredictable, consider the weathermen. They are constantly revising their forecasts, causing inconvenience not only to those pondering whether or not to take an umbrella, but also to commodity traders placing bets on how much gas and electricity will be needed for heating. When their predictions turn from cold snap to heat wave, say, it can play havoc with the forward price of gas.

WSI, a firm that owns the Weather Channel and sells forecasts of its own to airlines and other weather-dependent companies, has been grappling with this problem. Its solution is a new product called MarketFirst, a sort of forecast of the forecast. Every day, an hour before America's National Oceanic and Atmospheric Administration releases its updated forecast for the world's weather, WSI issues its own prediction of how the new bulletin will differ from the previous one. It does the same for the EU's official forecast. A year's subscription to MarketFirst, launched last November, costs $90,000, and WSI says it has already signed up a dozen customers.

...The more widespread MarketFirst becomes, the less useful it will be to its subscribers, Mr Scharf concedes, since markets would begin to move in response to its release, rather than to the forecasts it anticipates. So WSI considered various methods of selling it, including releasing it earlier to certain customers for a higher fee... [or selling] a forecast of the forecast of the forecast.
The same principle could apply to economic forecasts, of course, and that is essentially the service that good investment analysts and advisers provide to their clients. But whereas WSI boasts a 70% success rate in forecasting changes to weather forecasts, I think that most financial forecasters would be pretty happy with a success rate considerably below that.

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