Measuring Forecasting Accuracy

Abstract

We have seen that forecasting is essential for decision making in situations when the outcome is contingent upon something that will happen in the future. Whether or not a decision to hedge payables or receivables is taken depends on the forecast exchange rate. Whether the outcome turns out to be favourable or adverse depends on the accuracy of this forecast. This argument is true for all other decisions requiring exchange rate forecasting. Forecasting accuracy is important, as erroneous forecasts could lead to decisions with disastrous consequences. We have seen how the failure of the Beecham Group and Laker Airlines resulted from bad financing decisions that could have been based on faulty exchange rate forecasts.Whether the forecasting function is carried out in-house, bought from outside by subscribing to a forecasting service or both, the forecasts need regular monitoring and evaluation. If the forecasting function is performed in-house, evaluating the forecasting accuracy amounts to evaluating how well the forecasters do their job. If forecasts are obtained by subscribing to one or more services, evaluation is needed to assess the cost-effectiveness of buying the forecasts, to drop some forecasters and hire the services of others.