Reference class forecasting Totally Explained

Everything about Reference Class Forecasting totally explained

Reference class forecasting predicts the outcome of a planned action based on actual outcomes in a reference class of similar actions to that being forecast. The theories behind reference class forecasting were developed by Daniel Kahneman and Amos Tversky. They helped Kahneman win the 2002 Nobel Prize in Economics. Kahneman and Tversky (1979a, b) found that human judgment is generally optimistic due to overconfidence and insufficient consideration of distributional information about outcomes. Therefore, people tend to underestimate the costs, completion times, and risks of planned actions, whereas they tend to overestimate the benefits of those same actions. Such error is caused by actors taking an "inside view," where focus is on the constituents of the specific planned action instead of on the actual outcomes of similar ventures that have already been completed.
   Kahneman and Tversky concluded that disregard of distributional information, that is, risk, is perhaps the major source of error in forecasting. On that basis they recommended that forecasters "should therefore make every effort to frame the forecasting problem so as to facilitate utilizing all the distributional information that's available" (Kahneman and Tversky 1979b, p. 316).
   Using distributional information from previous ventures similar to the one being forecasted is called taking an "outside view." Reference class forecasting is a method for taking an outside view on planned actions.
   Reference class forecasting for a specific project involves the following three steps:

1. Identify a reference class of past, similar projects.
2. Establish a probability distribution for the selected reference class for the parameter that's being forecasted.
3. Compare the specific project with the reference class distribution, in order to establish the most likely outcome for the specific project.

Whereas Kahneman and Tversky developed the theories of reference class forecasting, Flyvbjerg and Cowi (2004) developed the method for its practical use in policy and planning. The first instance of reference class forecasting in practice is described in Flyvbjerg (2006). This was a forecast carried out in 2004 by the UK government of the projected capital costs for an extension of the Edinburgh Tram. The promoter's forecast estimated a cost of £255 million. Taking all available distributional information into account, based on a reference class of comparable rail projects, the reference class forecast estimated a cost of £320 million. Since the Edinburgh forecast, reference class forecasting has been applied to numerous other projects in the UK, including the £15 (US$29) billion Crossrail project in London. After 2004, The Netherlands, Denmark, and Switzerland have also implemented various types of reference class forecasting.
In 2005, the American Planning Association (APA) endorsed reference class forecasting and recommended that planners should never rely solely on conventional forecasting techniques:

"APA encourages planners to use reference class forecasting in addition to traditional methods as a way to improve accuracy. The reference class forecasting method is beneficial for non-routine projects ... Planners should never rely solely on civil engineering technology as a way to generate project forecasts" (the American Planning Association 2005).

Forecasts based on reference class forecasting and the outside view have been found to produce more accurate results than conventional forecasts based on the inside view. This is explained by the fact that reference class forecasting bypasses human bias, including optimism bias and strategic misrepresentation.

Further Information

Get more info on 'Reference Class Forecasting'.

External Link Exchanges

Do you know how hard it is to get a link from a large encyclopaedia? Well we're different and will prove it. To get a link from us just add the following HTML to your site on a relevant page:

<a href="http://reference_class_forecasting.totallyexplained.com">Reference class forecasting Totally Explained</a>

Then simply click through this link from your web page. Our crawlers will verify your link, extract the title of your web page and instantly add a link back to it. If you like you can remove the words Totally Explained and embed the link in article text.
As long as your link remains in place, we'll keep our link to you right here. Please play fair - our crawlers are watching. Your site must be closely related to this one's topic. Any kind of spamming, dubious practises or removing the link will result in your link from us being dropped and, potentially, your whole site being banned.