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Article

The Paradox Between Correlations and Sign Predictability

1
School of Business, Universidad Adolfo Ibáñez, Santiago 7941169, Chile
2
Facultad de Economía y Negocios, Universidad de Talca, Santiago 894000, Chile
*
Author to whom correspondence should be addressed.
Mathematics 2026, 14(5), 752; https://doi.org/10.3390/math14050752
Submission received: 18 December 2025 / Revised: 3 February 2026 / Accepted: 9 February 2026 / Published: 24 February 2026

Abstract

This paper uncovers a paradoxical disconnect between two widely used metrics for forecast evaluation: Mean Directional Accuracy (MDA) and the correlation between the forecast and the target variable. We show that a forecast that is more strongly correlated with the target may deliver poorer sign predictions than a less correlated alternative. Within a Gaussian framework, we derive analytical expressions showing that directional accuracy depends not only on correlation but also on the standardized means of both the forecast and the target variable. As a consequence, higher correlation does not guarantee superior sign predictability. We illustrate this paradox through analytical examples and derive formal conditions under which it cannot arise. Interestingly, we show that when forecasts are efficient, the MDA Paradox is impossible. Finally, we present an empirical application from the exchange rate literature that demonstrates the practical relevance of our results.
Keywords: forecasting; out-of-sample evaluation; mean squared prediction error; exchange rates forecasting; out-of-sample evaluation; mean squared prediction error; exchange rates

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MDPI and ACS Style

Pincheira, P.; Bentancor, A.; Reus, L. The Paradox Between Correlations and Sign Predictability. Mathematics 2026, 14, 752. https://doi.org/10.3390/math14050752

AMA Style

Pincheira P, Bentancor A, Reus L. The Paradox Between Correlations and Sign Predictability. Mathematics. 2026; 14(5):752. https://doi.org/10.3390/math14050752

Chicago/Turabian Style

Pincheira, Pablo, Andrea Bentancor, and Lorenzo Reus. 2026. "The Paradox Between Correlations and Sign Predictability" Mathematics 14, no. 5: 752. https://doi.org/10.3390/math14050752

APA Style

Pincheira, P., Bentancor, A., & Reus, L. (2026). The Paradox Between Correlations and Sign Predictability. Mathematics, 14(5), 752. https://doi.org/10.3390/math14050752

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