Reference class forecasting, or comparison class forecasting, is the method of

predicting the future, through looking at similar past situations and their outcomes.
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. The theoretical work helped Kahneman win the Nobel Prize in Economics.
Kahneman and Tversky
[1][2]
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 is available".
[2]:316
Using
distributional information from previous ventures similar to the one being forecast 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 is being forecast.
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).
[3]
This was a forecast carried out in 2004 by the UK
government of the projected capital costs for an extension of Edinburgh Trams. 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. A report issued in August 2011
estimated that the final cost of the yet unfinished project would be over 1 billion, for a
shorter tram line than the proposed Line 2.
[4]

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.
Before this, in 2001 (updated in 2006), AACE International (the Association for the
Advancement of Cost Engineering) included Estimate Validation as a distinct step in the
recommended practice of Cost Estimating (Estimate Validation is equivalent to
Reference class forecasting in that it calls for separate empirical-based evaluations to
benchmark the base estimate):
The estimate should be benchmarked or validated against or compared to historical
experience and/or past estimates of the enterprise and of competitive enterprises to
check its appropriateness, competitiveness, and to identify improvement
opportunities...Validation examines the estimate from a different perspective and using
different metrics than are used in estimate preparation.
[5]

In the process industries (e.g., oil and gas, chemicals, mining, energy, etc. which tend to
dominate AACE's membership), benchmarking (i.e., "outside view") of project cost
estimates against the historical costs of completed projects of similar types, including
probabilistic information, has a long history