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Valuing predictability

Antony Millner and Daniel Heyen

No 260, GRI Working Papers from Grantham Research Institute on Climate Change and the Environment

Abstract: How important is it to be able to predict the distant future? The authors of this paper study this question in a model of an agent who operates in a non-stationary stochastic environment. Payoffs depend on how well adapted activities are to current conditions, and activities may be adjusted to account for anticipated environmental changes, at a cost. The authors compute the value of prediction systems, which produce forecasts of the future with a given profile of accuracy as a function of lead time in every period. This allows them to quantify the importance of predictive accuracy at each lead time. Even if adjustment costs, discount factors and long-run uncertainty are large, short-run predictability is often more important than long-run predictability. ‘If you have to forecast, forecast often.’ Edgar R. Fiedler, The Three Rs of Economic Forecasting: Irrational, Irrelevant and Irreverent, 1977

Date: 2017-01
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