The difficulty of making predictions

Decision-Making

In separate work, from 2000 to 2010 German psychologist Gerd Gigerenzer compiled annual dollar-euro exchange rate predictions made by twenty-two of the most prestigious international banks – Barclays, Citigroup, JPMorgan Chase, Bank of America Merrill Lynch, and others. Each year, every bank predicted the end-of-year exchange rate. Gigerenzer’s simple conclusion about those projections, from some of the world’s most prominent specialists: “Forecasts of dollar-euro exchange rates are worthless.” In six of the ten years, the true exchange rate fell outside the entire range of all twenty-two bank forecasts.

Twenty-two banks supplied forecasts. In six of ten years, reality escaped the entire enclosure. The corporate response to uncertainty is usually another decimal place. Sales will produce £4.2 million. Launch will happen on 17 September. Headcount will be 314, as though demand, attrition and budgets signed the same calendar invitation. A precise number travels neatly into plans, so everyone pretends neatness came from the world rather than the spreadsheet. Then procurement, hiring and cash decisions gather around it as though precision were contagious.

“Nobody knows” is useless theatre too. Decisions still need money, dates and capacity. The honest alternative gives uncertainty a job: ranges, scenarios, probabilities and triggers. What changes if demand lands low? Which dependency moves the date? At what signal does hiring slow? What can be delayed without causing damage? Record the forecast before reality provides editing assistance, then compare confidence with performance. Otherwise each bad prediction disappears beneath a fresh number and the forecasting process enjoys permanent innocence.

A forecast earns its keep by improving action across plausible futures. Predicting one future with magnificent confidence may look better in a meeting, but so does a magician in good lighting. Finance should probably demand a less theatrical standard.