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Topic 3: ANOVA, Regression, and Forecasting

Module 3.4: Forecasting


Lecture 3.4.2: Stationary Time Series_Criteria
Forecasting Criteria
Suppose we have a system for forecasting the value of some variable at time t and we
have some actual values for the same variable. Let Ft denote the forecast at time t and let
At denote the actual value at time t. There are three major criteria, as follows:
n

A
Mean Absolute Deviation (MAD)

MAD =

(A
MSE =

Ft

Mean Square Error (MSE)

t=1

Ft ) 2

t=1

n
A F
At
t
MAPE = t=1
n
n

Mean Absolute Percentage Error (MAPE)

Note that MAD and MSE are, but MAPE is not, dependent on the unit of measurement.
All three criteria are used for stationary systems.

The comparative results for the DJI analysis is as follows:


Date
1-Feb-00
31-Jan-00
28-Jan-00
27-Jan-00
26-Jan-00
25-Jan-00
24-Jan-00
21-Jan-00
20-Jan-00
19-Jan-00
18-Jan-00
14-Jan-00
13-Jan-00
12-Jan-00
11-Jan-00
10-Jan-00
7-Jan-00
6-Jan-00
5-Jan-00
4-Jan-00
3-Jan-00
31-Dec-99

DJI
11041.05
10940.53
10738.87
11028.02
11032.99
11029.89
11008.17
11251.71
11351.3
11489.36
11560.72
11722.98
11582.43
11551.1
11511.08
11572.2
11522.56
11253.26
11122.65
10997.93
11357.51
11497.12

5-day MA
WMA
10954.06 10922.5373
10967.588 10931.5567
11070.156 11041.9853
11134.812 11077.5827
11226.086
11141.948
11332.252 11242.7353
11475.214 11398.4167
11541.358
11494.966
11581.318 11571.6387
11585.662 11603.7393
11587.958 11612.8187
11547.874
11554.45
11482.04 11520.9867
11396.35 11469.4033
11293.72
11396.95
11250.782 11289.8107
11245.694
11197.522

MAD
MSE
MAPE

MA errors
86.99
-27.058
-331.286
-106.792
-193.096
-302.362
-467.044
-289.648
-230.018
-96.302
-27.238
175.106
100.39
154.75
217.36
321.418
276.866

WMA errors
118.512667
8.97333333
-303.115333
-49.5626667
-108.958
-212.845333
-390.246667
-243.256
-220.338667
-114.379333
-52.0986667
168.53
61.4433333
81.6966667
114.13
282.389333
325.038

MA
WMA
200.219059 167.971412
53824.1776 39924.6573
0.01780341 0.01492173

(See the workbook entitles S271 DJI.xls for the analysis.)


Note that the weighted moving average is superior to the moving average on all three
criteria. This reveals a key point the MAD, MSE, and MAPE values are most useful
for comparing two (or more) different ways of making forecasts. However, the MAD,
MSE, and MAPE function can be used for finding the values of the optimal values of the
parameters that pertain to any forecasting method.
For example, we generated the weighted moving average forecasts by arbitrarily selecting
weights of 5, 4, 3, 2, and 1. We can do this in general to find optimal values to use in
place of 5, 4, 3, 2, and 1. This procedure involves the use of Solver (found under Tools
in Excel). [By the way, if you do not find Solver under Tools, you must activate it from
Add-Ins. Furthermore, there is no need to activate the version of Solver that came with
your text.]

For display purposes, we will find the MAD-optimal parameters for the five-day moving
average for the DJI data. The details of the analysis are available on the MADOPTIMAL page of the S271 DJI.xls workbook, which is as follows:
Date
DJI
5-day WMA
ABS(error)
31-Jan-00
10940.53 10742.6439
197.88605
28-Jan-00
10738.87 11028.1902 289.320151
27-Jan-00
11028.02
11033.078 5.05799927
26-Jan-00
11032.99 11032.9886 0.00143599
25-Jan-00
11029.89 11012.8383 17.0517298
24-Jan-00
11008.17 11254.9913
246.82128
21-Jan-00
11251.71 11354.1238 102.413766
20-Jan-00
11351.3 11492.1569 140.856864
19-Jan-00
11489.36 11560.9279 71.5678714
18-Jan-00
11560.72 11720.7518 160.031806
14-Jan-00
11722.98 11581.5581 141.421867
13-Jan-00
11582.43
11551.109 31.3209778
12-Jan-00
11551.1 11510.7619 40.3380532
11-Jan-00
11511.08 11567.8155 56.7354822
10-Jan-00
11572.2 11517.4892 54.7108255
7-Jan-00
11522.56 11250.5637 271.996301
6-Jan-00
11253.26
5-Jan-00
11122.65
4-Jan-00
10997.93
3-Jan-00
11357.51
31-Dec-99
11497.12
weights
w(t-1)
w(t-2)
w(t-3)
w(t-4)
w(t-5)

MAD

114.220779

3.74813372
0.00000000
0.04373837
0.00249728
0.00274425

Note that the MAD value of 114+ is lower than the previous value of 167+. Also note
that the optimal system of MAD weights is slightly odd in that w(t-2) is 0.
PROBLEM:
Find the weights for the MSE-optimal and MAPE-optimal five-day moving average
forecasts.

Exponential Smoothing
A commonly applied weighted forecasting technique is the exponential smoothing
method. The basic idea is this the forecasted value for time t, Ft+1, is the forecasted
value for time t, Ft, plus some fixed percentage, , of the error at time t-1, At Ft. Thus,
we have
Ft+1 = Ft + (At - Ft)
The open issue is the selection of . We use the foregoing three criteria to find the values
of .
For example, suppose we have the data set {1, 2, 1, 2, 1, 2}. Then the analyses of the
exponential smoothing forecasts are presented in the workbook S271 ExpoSmooth.xls,
and are as follows;
MAD analysis:
n

A
MAD =

t=1

Actual

Forecast

Error

ABS(A-F)

2
1
2
1
2
1

1
2
1
2
1
1

1
-1
1
-1
1
0

1
-1
1
-1
1
0

alpha =

1
MAD =

0.16666667

MSE Analysis:
n

(A
MSE =

Ft ) 2

t=1

Actual

Forecast

Error

(A-F)^2

2
1
2
1
2
1

1.29640535
1.39897619
1.19099236
1.25708512
1
1

0.70359465
-0.39897619
0.80900764
-0.25708512
1
0

0.49504544
0.159182
0.65449336
0.06609276
1
0

alpha =

0.25708512
MSE =

0.39580226

MAPE Analysis
n

MAPE =

t=1

At F
At
n

Actual

Forecast

Error

ABS((A-F)/A)

2
1
2
1
2
1

1
1
1
1
1
1

1
-8.0361E-10
1
-4.0181E-10
1
0

0.5
8.0361E-10
0.5
4.0181E-10
0.5
0

alpha =

4.0181E-10
MAPE =

0.25

Thus, the alphas for the MAD-, MSE-, and MAPE-optimal exponential smoothing
models are 1.000, 0.257, and 0.000, respectively.
PROBLEMS:
Ch. 6, #10a & b, 11a&b, 12a&b, and 13a&b

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