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Quantifying the Risk-Return Tradeoff in Forecasting

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  • Philippe Goulet Coulombe

Abstract

Average forecast accuracy is not the same as forecast reliability. I treat forecast loss differentials relative to a benchmark as a return series. I then evaluate these returns using risk-adjusted performance measures from finance, including the Sharpe ratio, Sortino ratio, Omega ratio, and drawdown-based metrics. I also introduce the Edge Ratio capturing a model's propensity to deliver uniquely informative predictions relative to the forecasting frontier. I apply this framework to U.S. macroeconomic forecasting, comparing econometric benchmarks, machine learning models, a foundation model (TabPFN), and the Survey of Professional Forecasters. While it is often feasible to beat professional forecasters in terms of average accuracy, it is much harder to beat them on a risk-adjusted basis. They rarely exhibit catastrophic failures and often achieve high Edge Ratios, plausibly reflecting the value of contextual judgment. Nonetheless, selected machine learning methods deliver attractive risk profiles for specific targets. The framework naturally extends to meta-analyses across targets, horizons, and samples, illustrated with a density forecast evaluation and the M4 competition.

Suggested Citation

  • Philippe Goulet Coulombe, 2026. "Quantifying the Risk-Return Tradeoff in Forecasting," Papers 2605.09712, arXiv.org.
  • Handle: RePEc:arx:papers:2605.09712
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    References listed on IDEAS

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