Question

Say the level of the market as measured by the Dow Jones Industrial Average is currently at 12,000. A forecaster has made a prediction of 13,300 for the level of the market in one year, along with a 95% confidence interval whose lower bound is 12,500 and whose upper bound is 14,500. You know from experience that this particular forecaster tends to be both excessively optimistic and miscalibrated. Describe how you might debias this individual. Give a numerical example (making up relevant numbers as appropriate).

Answer 1

Firstly, we must note that stock prices and stock index prices are a "random walk". So we can see that, one cannot predict the future of those prices which are based on historical data. It is true to say that stock price will go up in the long run. So 1 year is a ahort term period as it is not possible to predict the prices of one year from now .

Secondly, the DJIA has been over 13300 for over a short period in 2007. The DJIA went to 7000 in 2009. So the forecaster is assuming that DJIA will touch highest point in the coming year. On the other side, DJIA is expecting to grow more than 10% . The forecaster must look over the past historical data. By going through historical data, he can make relevant changes by understanding the overall economy. He will keep the predictions in mind that the economy is still unstable and make relevant changes.

As the economy start growing and recovers, DJIA will go up slightly may be 2 to 4% range. A 95%confidence interval will be below 12000 and maximum 13000.