The failure of forecasting - Arguments invoked by skeptics

Why do investors get forecasts wrong? Why are there failures with predictions? The forecast skeptic will say predictions cannot be made because of the properties of the world and the properties of the observers. We can classify reasons for failures into ontological or psychological arguments. 

Ontological: Properties of the world 

• Path dependencies
• Game theory
• Asymmetries between past and future 
• Complexity theory 

Psychological: Properties of observers 

• Preference for simplicity
• Belief in a controllable world
• Misunderstanding of probabilistic processes 
• Aversion to ambiguity

The ontological arguments state that forecasts fail because the world itself is difficult to characterize. The past may not match the future given that the world changes. There are path dependencies that limit forecast choices. The world is complex and thus unknowable, and game theory suggests that player behavior change when faced with changing situations. 

There are also psychological reasons for why forecasts will fail. There is a preference for simplicity which in reality may not exist. There is a belief that events are controllable when there may not be control. This is especially the case when forecasting the impact of policymakers. There is an aversion to ambiguity as forecasters assume their mental models work, and there are misunderstandings for how to measure or create probabilities. Investors are generally not good at measuring and assessing probabilities. 

The skeptic will say that forecasting is hard, yet awareness of arguments for failure can help improve forecasting skill. There are areas of forecasting failure and those can be minimized through explicit adjustment of thinking. Trend-following can be effective as a prediction tool through knowing the limitations or pitfalls that may exist with other forms of predicting. Discretion can be improved by awareness of ontological and psychological properties for potential failure.