Prediction

Definition

Prediction involves estimating future values based on past and present data using statistical models. Essential in finance, it helps in forecasting market trends, stock prices, and economic indicators.

5 Must Know Facts For Your Next Test

1. Predictions in finance often use linear regression models to establish relationships between variables.
2. The accuracy of a prediction depends on the quality and quantity of the data used.
3. Overfitting occurs when a model is too complex and captures noise instead of the underlying pattern.
4. Predictive power is evaluated using metrics like R-squared and Mean Squared Error (MSE).
5. Assumptions such as linearity, independence, homoscedasticity, and normality must be checked for reliable predictions.

Review Questions

• What statistical method is commonly used to make predictions in finance?
• Why is overfitting a problem in predictive modeling?
• List two metrics that are used to evaluate the accuracy of predictions.

Related terms

Linear Regression:

A statistical method that models the relationship between a dependent variable and one or more independent variables.

R-squared:

A statistical measure that indicates the proportion of variance in the dependent variable explained by the independent variable(s) in a regression model.

Mean Squared Error (MSE): A metric that measures the average squared difference between observed actual outcomes and predicted values.