International Journal of Forecasting 25 (2009) 840844

www.elsevier.com/locate/ijforecast

Living in a world of low levels of predictability

Spyros Makridakis a, , Nassim Taleb b,1
a INSEAD, Boulevard de Constance, 77305 Fontainebleau, France
b Polytechnic Institute of NYU, Department of Finance and Risk Engineering, Six MetroTech Center, Rogers Hall 517 Brooklyn,

NY 11201, USA

Abstract
This conclusion aims to summarize the major issues surrounding forecasting, as well as the extensive empirical evidence
proving our inability to accurately predict the future. In addition, it discusses our resistance to accepting such inaccurate
predictions, while putting forwards a number of ideas aimed at a complex world where accurate forecasting is impossible
and where uncertainty reigns.
c 2009 International Institute of Forecasters. Published by Elsevier B.V. All rights reserved.

Keywords: Forecasting; Accuracy; Black Swans; Low level predictability; Illusion of control; Paradox of control

1. Introduction
This special section has established the serious
limits of predictability in practically all important
areas affecting us. The critical question is, how can
we plan, formulate strategies, invest our savings,
manage our health, and generally make future oriented
decisions, accepting that there are no crystal balls?
This is a big challenge that must be faced head on
to avoid unpleasant surprises and the catastrophic
consequences that come from the illusion that accurate
forecasting is possible, and that future uncertainty can
be correctly assessed and effectively controlled. The
current recession, the most serious one since the great
Corresponding author. Tel.: +30 6977661144.

E-mail addresses: smakrid@otenet.gr (S. Makridakis),

nnt@fooledbyrandomness.com (N. Taleb).
1 Tel.: +1 718 260 3599; fax: +1 718 260 3355.

depression, is a prime example of the serious limits

of predictability, as its arrival, depth and devastating
consequences were not predicted even in the summer
of 2008, even though, according to the National
Bureau of Economic Research (NBER), the recession
started in December 2007. At the time of writing
this article, this recession has resulted in more than
$35 trillion in stock market losses around the world,
and several trillion of taxpayers money being used
to bail out falling firms and jump-start the economy.
Worst of all, nobody seems to be sure whether this
huge amount of money being spent will achieve its
intended purposes,2 how long the recession will last,
2 There are widespread criticisms and considerable doubts about
the huge $350 billion TARP fund spent up to the end of 2008 and
its contribution to helping the economy, which is still deteriorating,
forcing Obamas economic team to want to re-evaluate how the
remaining $350 billion will be spent.

c 2009 International Institute of Forecasters. Published by Elsevier B.V. All rights reserved.
0169-2070/$ - see front matter
doi:10.1016/j.ijforecast.2009.05.008

S. Makridakis, N. Taleb / International Journal of Forecasting 25 (2009) 840844

how high unemployment will rise, or whether the

banking sector, or at least several big banks, will have
to be nationalized.
2. The resistance to accepting the inaccuracy of
forecasting
In 1981 the first author published a paper
entitled If we cannot forecast how can we plan?
(Makridakis, 1981), and the following year he
published another paper, A chronology of the last
six recessions (Makridakis, 1982). The first paper,
as its title suggests, was pointing out our inability
to accurately predict economic and business events,
and was proposing that we accept such an inability,
instead of illusorily relying on the predictions being
correct when planning and formulating strategies.
The second paper proved the inability of economists
to forecast forthcoming recessions that were often
confirmed long after they had started, as has been the
case with the 2007/2009 recession which the NBER
ratified on November 28, 2008, as having began
in December 2007. These two papers and those of
the M-Competitions (Makridakis et al., 1982, 1993;
Makridakis & Hibon, 2000) confirmed our inability
to accurately predict and the existence of large
forecasting errors in the domain of business, economy
and finance. However, the majority of academics and
business people were not willing to accept these
findings, and instead preferred the illusion of control,
pretending that accurate forecasting was possible.
It was not until the publication by the second
author of Fooled by Randomness (Taleb, 2001, 2004)
and The Black Swan (Taleb, 2007) that attitudes
started changing, as many people began to accept the
serious limits of forecasting when complex, social
systems are involved, as well as the catastrophic
consequences of Black Swans. However, there are
still large numbers of decision makers and individuals
who believe that accurate forecasting is possible,
and that uncertainty can be assessed correctly and
controlled effectively. Worse, a large number of
academics feed such beliefs by introducing models
that are supposed to forecast and assess uncertainty
accurately. Below we summarize the evidence and
suggest alternative strategies if we accept low levels of
predictability and its consequence of huge uncertainty
(see also Makridakis, Hogarth, & Gaba, 2009).

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3. Why accurate forecasting is not possible:

Empirical findings
The future isnt it what it used to be, or alternatively, history never repeats itself in exactly
the same way. This means that statistical models that extrapolate (or interpolate) past patterns/relationships cannot provide accurate predictions, since they presume that such patterns/relationships will not change (assumption of
constancy). Alternatively, one may say that the relationships are constant, nothing has changed, but
that the measurements and models are lacking in
sophistication to capture nonlinearities.
Statistically sophisticated, or complex, models fit
past data well, but do not necessarily predict the
future accurately meaning that they have been
data-mined.
Simple models do not necessarily fit past data
well, but predict the future better than complex or
sophisticated statistical models.
Ironically, in most domains, judgmental predictions
are less accurate than those of statistical models,
as they are influenced by human biases and
limitations.
Experts do not seem to forecast more accurately
than knowledgeable individuals.
Averaging the predictions of several/many individuals usually improves forecasting accuracy, though
the rate might not be significant with fat-tailed domains.
Averaging the forecasts of two or more models
improves accuracy while also reducing the variance
of forecasting errors.
Statistical models underestimate uncertainty, sometimes catastrophically, because they assume that
Events are independent: This is a serious
mistake, as the world has become a global village
and what happens in a specific situation (e.g. the
toxic mortgages in USA) can seriously affect
the entire international financial system. This
means that diversification does not work, as the
great majority of countries, economic sectors,
industries and firms are interdependent, and are,
therefore, influenced in similar ways. Note how
macroeconomic data might exhibit independence
for small or intermediate variations, and high codependence for large fluctuations.

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Forecasting errors are tractable: This is not true

in the great majority of financial and business
situations, which are characterized by long, fat
tails and extreme errors. A lack of normality
means that errors, and therefore uncertainty, are
much greater than those postulated by models,
while, in addition, there can be cataclysmic
events (like Black Mondays and Tuesdays) that
are impossible if the normality of errors is
assumed, but whose consequences are tragic for
both individuals and organizations.
The variance of forecasting errors is finite,
known and constant: This is another serious
problem when using statistical models. For
example, the stock market volatility in 2008 was
considerably higher than in previous years. The
consequence of this is much greater uncertainty
and many surprises.
Humans, driven by over-optimism and wishful
thinking, often underestimate uncertainty even
more than statistical models.
There are always new and unforeseen events,
Talebs Black Swans, that cannot be predicted beforehand and that further increase future uncertainty.
The above empirical evidence has been replicated
by numerous studies and has been verified in
practice. Thus, we must realize that although accurate
forecasting is possible in some areas of physics
and engineering, it fails when complex systems are
involved. Moreover, such a failure becomes more
pronounced in complex social systems where the
actions and reactions of people can and do affect future
outcomes.
4. What to do when accepting low levels of
predictability
1. Avoid the illusion of control: Accepting that no
accurate predictions are possible is psychologically
disturbing, as it makes obvious our lack of
control over future outcomes, and its consequences
of high levels of uncertainty. However, as the
three examples listed below show, there can be
considerable benefits if we accept that accurate
predictions are not possible:

By investing our money believing that professional fund managers are capable of predicting
stocksbetter than chance, our returns are lower
than if we select stocks randomly, as is done by
index funds. The reality is different, as the following quote proves. Over the past two decades
the annual return of the average equity fund
(10%) has lagged the return of the S&P 500 Index (13%) by 3% points per year, largely because of those pesky fund costs. To make matters
worse, largely because of poor timing and poor
fund selection, the return actually earned by the
average fund investor has lagged the return of the
average fund by another 3% points, reducing it to
just 7% per yearroughly 50% of the markets
annual return.3
By driving a car instead of taking a plane, as
many people did after 9/11 for fear of another
terrorist attack, it seems that fatal car accidents
increased relative to the previous year by an
estimated 5,000, while there were zero deaths in
airplane accidents between 9/11 and the end of
2002. Thus, by being willing to accept a lack of
control (or inability to accurately predict terrorist
attacks), people would have avoided dying while
driving their cars instead of taking a plane.
By believing that periodic checkups increase
our life expectancy we spend considerable sums
of money and go through undue discomfort
doing such tests without any benefits, as
those doing these checkups do not live longer
than those who do not. Type-2 errors, with
consequences commonly known as iatrogenics
(harm caused by the healer) are prevalent in
borderline situations.
The above point to what psychologists call
the paradox of control, which results in improved
benefits if we avoid the illusion of control and
instead accept that accurate forecasting is not
possible. This is precisely what happened in the
three examples just mentioned.
2. Protective strategies: This strategy is followed by
a large number of people and organizations who
want to protect themselves against the negative
consequences of unpredictable events. Such events
can include: car accidents, thefts, fires, extreme
temperatures or other harmful weather conditions
3 Bogle Financial Markets Research Center (see Bogle, 2006).

S. Makridakis, N. Taleb / International Journal of Forecasting 25 (2009) 840844

3.

4.

5.

6.

(floods, hurricanes etc.), earthquakes, terrorists

attacks,and so on. In the financial world, protective
strategies take the form of hedging, swaps, and
all shorts of derivatives (short selling, puts etc.)
aimed at reducing future risk. Moreover, there
are proposals (see Shiller, 2004) to expand these
protective strategies by embracing a much wider
range of factors: from peoples income to countries
GNP though we may need to be careful about
counterparty/contract risks.
Being prepared: Being prepared to face difficult,
negative or dangerous events is as old as human
civilization, and is an activity that distinguishes humans from most of the animals. Such activities have
included building shelters, domesticating animals,
storing food for the winter, and a host of other
actions. The same principle applies when we are
unable to predict events like earthquakes, floods,
storms, hurricanes and similar destructive events. In
such cases, in addition to buying insurance, we can
build adequate structures to withstand, for instance,
strong earthquakes or hurricanes, or be financially
strong to endure economic crises.
Proactive strategies: Redundancy is a strategy that
increases survival in complex systems. In addition to being prepared to face difficult situations,
the next step is to be proactive by building reserves to be used specifically for particular negative
events that are bound to repeat themselves in the future. The same way, for instance, that there is an
accounting reserve for bad debts that we cannot
predict, there can also be a reserve for economic
slowdowns and recessions that would be built during periods of economic expansions and be used in
economic downturns. If such a reserve were institutionalized, it would decrease fluctuations in earnings and the negative consequences of recessions or
other cyclical occurrences.
The VC approach: Venture Capitalists (VC) benefit from forecast errors, since negative errors do
not hurt them beyond the small investment, and errors in the opposite direction can represent massive
windfalls. They tend to diversify their bets across a
broad range of investments.
The maxmin approach: The maxmin approach goes
one beyond the VC by seeking out large gains but
at a fixed known cost (e.g. buying options or puts),
while investing the great majority of the resources
in minimal or no risk investments.

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7. Concentrating on uncertainty: We can always

make a prediction, either judgmentally or using a
statistical/mathematical model. Once such a forecast exists, a more difficult task and bigger challenge is to assess its accuracy, or alternatively, the
uncertainty involved, as the reality can sometimes
be substantially different from the forecast. Unfortunately, however, most of the emphasis in predicting social science events has been on forecasting,
rather than assessing uncertainty correctly and realistically. The biggest difficulty in such assessments comes from the fact that the greatest uncertainty is from rare events whose probability of
occurrence cannot be estimated, because, by definition, such events are infrequent, while also appearing at highly varying intervals. These types of
events, which the second author has called Black
Swans, are ignored, and often treated as outliers,
though they cause extensive damage, often greater
than the cumulative benefits of decades (the perfect
example of a Black Swan is the huge cost of the
current financial crisis, which was not predicted except by a handful of people, while its consequences
were completely missed by all models).
In summary, globalization has brought many
benefits to the world, but it has also increased the
degree of interdependence of our economies and
financial institutions, as well as that of our business
firms. The positive aspect of globalization has been
greater prosperity and prolonged life expectancy, the
negative side effect is that a recession or financial
crisis in one country has repercussions for the entire
world, leading to an increase in the possibility of
extreme outcomes. Unfortunately we must learn to live
with this fact, knowing perfectly well that forecasting
can provide no help in more accurately predicting
when the next recession or financial crisis will occur,
or its consequences. However, fortunately, we can
make an effort to insulate ourselves from the sting of
unpredictable and extreme events.
References
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Makridakis, S. (1982). A chronology of the last six recessions.
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