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I. Introduction
-- What is forecasting?
Scientific (educated) guess
Based on past data or experience
Rarely perfect
Group forecast more accurate
Shorter time horizon, more accurate
-- Why forecasting?
-- Pattern of Data
Trend – gradual upward or downward movement
Seasonality – repeated pattern
Cycle – background pattern over long period of time
Randomness – unexplainable, unpredictable, unknown fluctuations
Naive: Ft+1 = Yt
Exponential Smoothing with smoothing constant : very little data record required, more
weight on recent data, weight decreases exponentially
Ft+1 = Ft +α (Yt - Ft) = αYt + (1-α)F t 0 < 1,
-- Example: Forecast the score for test 5 by the above smoothing techniques with and
F1 = 77.
Test 1 2 3 4 5
Avg.Score 72 82 85 90 ?
-- Thinking challenge:
1. Which method requires the least amount of data?
2. What happens if the in the exponential smoothing method increases?
Step 1. Find a trend line y = a + bx to fit the past data the best (minimizing mean squared
errors)
b
xy n x y
best slope:
x2 nx
2
best intercept: a y b x
where x and y are averages of x’s and y’s
-- Example continues:
X y xy x2 y2
* Excel commands:
calculating b:“=slope(range of y’s, range of x’s)”
calculating a:“=intercept(range of y’s, range of x’s)”
Step 2. Trend projection
Trend projection forecast: Fnext = a + b*xnext
-- Example continues:
* Excel commands:
calculating Sy,x:”=steyx(range of y’s, range of x’s)”
-- Example: The sales manager of a large apartment rental complex feels the demand for
apartments may be related to the number of newspaper ads placed during the previous month.
She has collected the data shown below.
Ads 15 9 40 20 25 25 15 35
Rental 6 4 16 6 13 9 10 16
If the number of ads placed in this month is 30, what would be her estimate of rentals in the
coming month?
-- Interpretation:
r > 0:
r = 0:
r < 0:
r2 = coefficient of determination: % of variation in the dependent variable (y) is explained
by regression equation (linear relationship).
-- Example continued: How strong is the relationship between the ads placed and the rentals?
4) Decomposition of Time Series
- for data with both trend and seasonality patterns, short to medium term
-- Idea:
1. Decompose the past data (filter out the seasonal influence from original data)
2. Forecast trend pattern and seasonality pattern separately
3. Combine the forecasts using the multiplicative model: Y t = Tt * St
-- Example: Data of a popular brand of sweater sale (by quarters) over the past three years:
2000 Sale 2001 Sale 2002 Sale
(t) (Yt) (t) (Yt) (t) (Yt)
1 12 5 16 9 18
2 25 6 32 10 45
3 76 7 80 11 84
4 52 8 62 12 60
Forecast the sale of each season in 2003.
Step 1. Draw the historical data diagram to check if there is an obvious seasonal pattern
Y =
Step 4. Calculate the trend based on the deseasonalized demand by linear regression T t = a
+ bt
a= b=
Step 5. Use trend projection to forecast the demand with trend only.
T13 = T14 =
T15 = T16 =
Step 6. Use seasonal indexes to modify the forecasts to reflect the seasonality patterns: F = T
*S
F13 = F14 =
F15 = F16 =