FORECASTING TECHNIQUES (DQQ 8043)

NOR IDAYU MAHAT

Department of Physical Science (Statistics)

College of Art and Sciences, Universiti Utara Malaysia
Tel: 04-928 4098, e-mail: noridayu@uum.edu.my

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 Course Summary

• Objectives:
• to learn some statistical methods for forecasting
purposes and
• to understand the concepts and ideas used in
forecasting.

• Evaluation:
• Coursework 70%
• Individual test (10%): 1 hour multiple choice test
• Group assignment I (30%): report writing
• Group assignment II (30%): presentation
• Final exam 30%
2 hours open book examination.

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 Course Summary

• References
• Text book: Bowerman, B. L., O’Connell, R.T. and
Koehler, A.B. (2005). Forecasting, Time Series and
Regression. California: Thomson.
• Other references as suggested in the syllabus or any
relevant books.

• Software: any relevant software but Excel and SPSS are

preferable.

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 Introduction to Forecasting

What does forecasting mean?

• Forecast - predictions of future events or conditions.
• Forecasting - activity of making such predictions.

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 Introduction to Forecasting

What does forecasting mean?

• Forecast - predictions of future events or conditions.
• Forecasting - activity of making such predictions.
• Forecasting techniques have been widely used in many
areas: demand in consumer preferences, production
scheduling, strategic management, weather forecast, sport
forecast etc.

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 Introduction to Forecasting

What does forecasting mean?

• Forecast - predictions of future events or conditions.
• Forecasting - activity of making such predictions.
• Forecasting techniques have been widely used in many
areas: demand in consumer preferences, production
scheduling, strategic management, weather forecast, sport
forecast etc.
• Forecasting strategy:
1. Identify a pattern based on the existing data.
2. Choose a suitable method to model the pattern.
3. Measure the performance of the constructed model.
4. If it is accepted and the pattern is believed to be
continued in the future, then use the model for prediction
purpose.
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 Basic Consideration to Successful Forecasting

• What are the implications of the forecasting modeling in the

decision environment?
• What is the object that we want to forecast?
• How do we wish to state our forecasts? What is the
statement of our forecast?
• What is the forecast horizon?
• Are the available data simply the past history of the series
to be forecast?
• What forecasting method is best suited to the needs of a
particular forecasting problem?

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 Basic Understanding about Forecasting

• Types of data
• cross-sectional
• time series
• functional
• area/geography and many more

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 Basic Understanding about Forecasting

• Types of data
• cross-sectional
• time series
• functional
• area/geography and many more

• Factors that must be considered in choosing appropriate

forecasting method
• Time frame
• The pattern of data
• The cost (collecting the data, performing the analysis,
forecasting etc.)
• The accuracy desired
• The ease of operation and understanding
• The demand of customer and stakeholder
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 Forecasting Methods

• Basic types: qualitative methods and quantitative

methods.

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 Forecasting Methods

• Basic types: qualitative methods and quantitative

methods.
• Qualitative methods
• Decision is made based on knowledge and experiences
of experts.
• Subjective decision making.

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 Forecasting Methods

• Basic types: qualitative methods and quantitative

methods.
• Qualitative methods
• Decision is made based on knowledge and experiences
of experts.
• Subjective decision making.

• Quantitative methods
• Decision is made based on the results obtained from the
analysis of the historical data.

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 Qualitative Method

• Some common methods

1. Subjective curve fitting (e.g. product life cycle,
exponential curve).
2. Delphi method: opinion based on a panel of experts.
3. Time-independent technological comparisons.

• These techniques are sensible to use when

• unavailable of historical data, or
• decision is made in non-critical problem.

• Some weaknesses of qualitative methods

• All predictions are subjective.
• Difficult to measure how good/reliable the decision that
has been made for future use.
• Different experts may give different opinions.
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 Quantitative Methods

• These methods can be classified into mathematical and

algorithm approaches.
• Quantitative methods depend on
• Number of variables.
• Types of variables.
• Size of sample data.

• Types of forecast: point forecast or interval forecast.

• Forecasting contains errors!

• It’s occur because forecasting involve some degrees of
uncertainty.
• Errors may be caused by irregular components,
unpredictable events or researcher mistake.
• Size of error must be as small as possible.
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 Some Issues in Formulating Quantitative Model

• Accuracy of the forecast using the constructed model.

• Forecast horizon as it can influence the decision making.
• Changes in technologies may effect the significant of
forecast.
• Availability of information/data.
• Others surrounding influences:
• Control from authorize bodies or the government
• Unpredictable changes: e.g. natural disaster
• Cost

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 Factors that Contribute to False Forecast

There can be many factors that contribute to false forecast or

prediction. However most of these are due to
• Do not understand the problem!!
• Using inappropriate data for achieving the determined
objective(s).
• Implementing wrong models.
• Applying wrong assumptions.
• Using bias models for prediction purpose:
• Using complex methods with insufficient knowledge
about them.
• Performing wrong statistical testing.
• Including unnecessary variables in the constructed
models.
• Using messy data.
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 Forecasting Procedure

1. Identification and determination of the purpose and the

objective of the forecasting study
2. Selecting of relevant theory
3. Collection of data (primary of secondary data)
4. Initial analysis on the data
5. Model construction
6. Assessing the constructed model
7. Forecast
8. Documentation

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 Reviewing on Some Statistical Concepts

• Objects and variables

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 Reviewing on Some Statistical Concepts

• Objects and variables

• Population
• The entire collection of objects or observations about
which information is desired.
• Number of observations in population may finite or
infinite.
• Values obtain from population are called parameters e.g.
mean, standard deviation, range, maximum and
minimum values etc.

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 Reviewing on Some Statistical Concepts

• Objects and variables

• Population
• The entire collection of objects or observations about
which information is desired.
• Number of observations in population may finite or
infinite.
• Values obtain from population are called parameters e.g.
mean, standard deviation, range, maximum and
minimum values etc.
• Sample
• A sample contains some selected objects or
observations from the target population.
• We often use sample when values of parameters that we
are interested into are unavailable (unknown).
• To avoid bias in estimation, random sample should be
used. FORECASTING TECHNIQUES (DQQ 8043) – p. 13/21
 Initial Data Analysis

• Aims:
• to uncover any patterns that may be present in the data.
• to understand the distribution of the data.
• to identify any anomalies, if exist.

• The best way to discover pattern in the data is through

visualisation.
• Sometimes, table (tabular) may be appropriate.

• Simple statistics can be used such as the location values,

the variation values and the linear association values. If
appropriate, inferential analysis can be done.

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 Example: New York Air Quality

60 70 80 90

20
15
Wind

10
5
90
80

Temp
70
60

8.0
7.0
Month

6.0
5.0
5 10 15 20 5.0 6.0 7.0 8.0
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 Example: Iris

2.0 3.0 4.0 0.5 1.5 2.5

7.5
6.5
Sepal.Length

5.5
4.5
4.0

Sepal.Width
3.0
2.0

1 2 3 4 5 6 7
Petal.Length
2.5
1.5

Petal.Width
0.5

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 Inferential Statistics
• Hypothesis testing that
• evaluates the correctness of the estimated value
• tests for the existence of relationship between variables
• compares two or more populations
• many more . . .

• Modelling
• to understand behaviour between variables or objects.
• to uncover relationship between variables so that some
predictions for future use can be made.

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Example: Quality Home Improvement Center (QHIC)

QHIC operates five stores in a large metropolitan area. The

marketing department at QHIC wishes to study the relationship
between home value (in thousand $), x, and yearly
expenditure on home upkeep ($), y . A random sample of 40
homeowners is taken, and they are asked to estimate their
expenditures during the previous year on the types of home
upkeep products and services offered by QHIC.

Some information of this sample:

• Average home value: $174.49
• Average yearly to upkeep the house: $918.09
• Pattern of relationship between two variables: straight line /
linear

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 Model Construction

• Some existing statistical forecasting techniques.

• Regression analyses (simple, nonlinear or multiple).
• Regression time series.
• Classical decomposition.
• Exponential smoothing.
• Box-Jenkins methods.

• Other methods
• Non-parametric time series.
• Robust time series.

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 Model Assessment
• An important process to
• measure the performance of the constructed model.
• check the validity of the constructed model.

• The indicator can be different, depends on the aim of the

study. However, in general, error is used.

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 Model Assessment
• An important process to
• measure the performance of the constructed model.
• check the validity of the constructed model.

• The indicator can be different, depends on the aim of the

study. However, in general, error is used.

Error can be measured as a different between the actual and the

predicted values, et = yt − ŷt , where t = 1, . . . , n.

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 Model Assessment
• An important process to
• measure the performance of the constructed model.
• check the validity of the constructed model.

• The indicator can be different, depends on the aim of the

study. However, in general, error is used.

Error can be measured as a different between the actual and the

predicted values, et = yt − ŷt , where t = 1, . . . , n.
• Actual value (yt ) is a value collected from the actual event.
• Predicted value (ŷt ) is a value estimated (obtained) from the
constructed model.

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 Some Indicators to Measure Error

Let yt be the actual value from the obtained data and its
associated predicted value be labeled as ŷt . Then, the forecast
errors might be measured using
Pn
1. Sum of errors: (yt − ŷt )
t=1
P
n
2. Sum of squared of errors: (yt − ŷt )2
t=1
P
n
3. Mean absolute deviation of error: |yt − ŷt |/n
t=1
P
n
4. Mean squared of error: (yt − ŷt )2 /n
t=1

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