The Value of a Probability Forecast from Portfolio Theory
A probability forecast scored ex post using a probability scoring rule (e.g. Brier) is analogous to a risky financial security. With only superficial adaptation, the same economic logic by which securities are valued ex ante â€“ in particular, portfolio theory and the capital asset pricing model (CAPM) â€“ applies to the valuation of probability forecasts. Each available forecast of a given event is valued relative to each other and to the â€œmarketâ€\x9D (all available forecasts). A forecast is seen to be more valuable the higher its expected score and the lower the covariance of its score with the market aggregate score. Forecasts that score highly in trials when others do poorly are appreciated more than those with equal success in â€œeasyâ€\x9D trials where most forecasts score well. The CAPM defines economically rational (equilibrium) forecast prices at which forecasters can trade shares in each otherâ€™s ex post score â€“ or associated monetary payoff â€“ thereby balancing forecast risk against return and ultimately forming optimally hedged portfolios. Hedging this way offers risk averse forecasters an â€œhonestâ€\x9D alternative to the ruse of reporting conservative probability assessments. Copyright Springer Science+Business Media, LLC 2007
Volume (Year): 63 (2007)
Issue (Month): 2 (September)
|Contact details of provider:|| Web page: http://www.springer.com|
|Order Information:||Web: http://www.springer.com/economics/economic+theory/journal/11238/PS2|
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Milne, Frank, 2003. "Finance Theory and Asset Pricing: Second Edition," OUP Catalogue, Oxford University Press, edition 2, number 9780199261079.
- Bertrand Maillet & Emmanuel Jurczenko, 2002. "The 3-CAPM: Theoretical Foundations and a Comparison of Asset Pricing Models in an Unified Framework," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-00308997, HAL.
- Robert Nau, 2001. "De Finetti was Right: Probability Does Not Exist," Theory and Decision, Springer, vol. 51(2), pages 89-124, December.
- James E. Matheson & Robert L. Winkler, 1976. "Scoring Rules for Continuous Probability Distributions," Management Science, INFORMS, vol. 22(10), pages 1087-1096, June.
- Daniel Friedman, 1983. "Effective Scoring Rules for Probabilistic Forecasts," Management Science, INFORMS, vol. 29(4), pages 447-454, April.
- repec:bla:joares:v:17:y:1979:i:1:p:156-178 is not listed on IDEAS
- Epstein, Larry G, 1985. "Decreasing Risk Aversion and Mean-Variance Analysis," Econometrica, Econometric Society, vol. 53(4), pages 945-961, July.
- Robert T. Clemen & Robert L. Winkler, 1990. "Unanimity and Compromise Among Probability Forecasters," Management Science, INFORMS, vol. 36(7), pages 767-779, July.
- K. Borch, 1969. "A Note on Uncertainty and Indifference Curves," Review of Economic Studies, Oxford University Press, vol. 36(1), pages 1-4.
- R. Winkler & Javier Muñoz & José Cervera & José Bernardo & Gail Blattenberger & Joseph Kadane & Dennis Lindley & Allan Murphy & Robert Oliver & David Ríos-Insua, 1996. "Scoring rules and the evaluation of probabilities," TEST: An Official Journal of the Spanish Society of Statistics and Operations Research, Springer;Sociedad de Estadística e Investigación Operativa, vol. 5(1), pages 1-60, June.
- Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, vol. 77(3), pages 421-430, June.
- Leonard MacLean & Yonggan Zhao & William Ziemba, 2011. "Mean-variance versus expected utility in dynamic investment analysis," Computational Management Science, Springer, vol. 8(1), pages 3-22, April.
- Murphy, Allan H. & Winkler, Robert L., 1992. "Diagnostic verification of probability forecasts," International Journal of Forecasting, Elsevier, vol. 7(4), pages 435-455, March.
- Mark Grinblatt & Sheridan Titman, "undated". "Portfolio Performance Evaluation: Old Issues and New Insights," Rodney L. White Center for Financial Research Working Papers 22-88, Wharton School Rodney L. White Center for Financial Research.
- Kroll, Yoram & Levy, Haim & Markowitz, Harry M, 1984. " Mean-Variance versus Direct Utility Maximization," Journal of Finance, American Finance Association, vol. 39(1), pages 47-61, March.
- Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-317, June.
- Kraus, Alan & Litzenberger, Robert H, 1976. "Skewness Preference and the Valuation of Risk Assets," Journal of Finance, American Finance Association, vol. 31(4), pages 1085-1100, September.
- LeRoy,Stephen F. & Werner,Jan, 2014.
"Principles of Financial Economics,"
Cambridge University Press, number 9781107024120, February.
- LeRoy,Stephen F. & Werner,Jan, 2001. "Principles of Financial Economics," Cambridge Books, Cambridge University Press, number 9780521586054.
- LeRoy,Stephen F. & Werner,Jan, 2014. "Principles of Financial Economics," Cambridge Books, Cambridge University Press, number 9781107673021, February.
When requesting a correction, please mention this item's handle: RePEc:kap:theord:v:63:y:2007:i:2:p:153-203. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla)or (Rebekah McClure)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.