Forecasting Methods in Finance

Our review highlights some of the key challenges in fi nancial forecasting problems along with opportunities arising from the unique features of fi nancial data. We analyze the difficulty of establishing predictability in an environment with a low signal-to-noise ratio, persistent predictors, and instability in predictive relations arising from competitive pressures and investors’ learning. We discuss approaches for forecasting the mean, variance, and probability distribution of asset returns. Finally, we cover how to evaluate fi nancial forecasts while accounting for the possibility that numerous forecasting models may have been considered, leading to concerns of data mining.