Probabilistic forecasting with discrete choice models: Evaluating predictions with pseudo-coefficients of determination

Probabilistic forecasts from discrete choice models, which are widely used in marketing science and competitive event forecasting, are often best evaluated out-of-sample using pseudo-coefficients of determination, or pseudo-R2s. However, there is a danger of misjudging the accuracy of forecast probabilities of event outcomes, based on observed frequencies, because of issues related to pseudo-R2s. First, we show that McFadden’s pseudo-R2 varies predictably with the number of alternatives in the choice set. Then we evaluate the relative merits of two methods (bootstrap and asymptotic) for estimating the variance of pseudo-R2s so that their values can be appropriately compared across non-nested models. Finally, in the context of competitive event forecasting, where the accuracy of forecasts has direct economic consequence, we derive new R2 measures that can be used to assess the economic value of forecasts. Throughout, we illustrate using data drawn from UK and Ireland horse race betting markets.