Statistical Forecasting Models

(Lesson - 07)

Best Bet to See the Future

Dr. C. Ertuna

Statistical Forecasting Models

Time Series Models: independent variable is time.
Moving Average Exponential Smoothening Holt-Winters Model

Explanatory Methods: independent variable is one or more factor(s).

Regression
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Time Series Models

Statistical Time Series Models are very useful for short range forecasting problems such as weekly sales. Time series models assume that whatever forces have influenced the variables in question (sales) in the recent past will continue into the near future.
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Time Series Components

A time series can be described by models based on the following components Tt Trend Component St Seasonal Component Ct Cyclical Component It Irregular Component Using these components we can define a time series as the sum of its components or an additive model

Alternatively, in other circumstances we might define a time series as the product of its components or a multiplicative model often represented as a logarithmic model

X t Tt St Ct I t X t Tt St Ct I t
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Components of Time Series Data

A linear trend is any long-term increase or decrease in a time series in which the rate of change is relatively constant. A seasonal component is a pattern that is repeated throughout a time series and has a recurrence period of at most one year. A cyclical component is a pattern within the time series that repeats itself throughout the time series and has a recurrence period of more than one year.
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Components of Time Series Data

The irregular (or random) component refers to changes in the time-series data that are unpredictable and cannot be associated with the trend, seasonal, or cyclical components.

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Stationary Time Series Models

Time series with constant mean and variance are called stationary time series. When Trend, Seasonal, or Cyclical effects are not significant then a) Moving Average Models and b) Exponential Smoothing Models are useful over short time periods.
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Moving Average Models

Simple Moving Average forecast is computed as the average of the most recent k-observations. Weighted Moving Average forecast is computed as the weighted average of the most recent k-observations where the most recent observation has the highest weight.
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Moving Average Models

Simple Moving Average Forecast
Ft E ( Yt ) i t k k Weighted Moving Average Forecast

t 1

Ft E ( Yt ) i t k k

wY
i

t 1

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Weighted Moving Average

Actual Month Burgla rie s 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 MSE = RMSE = 88 44 60 56 70 91 54 60 48 35 49 44 61 68 82 71 50 wMA(k =3) 100.00% =SUM(C4:C6) 0.1 0.3 0.6 58.0 56.0 64.8 81.2 66.7 61.3 52.2 41.4 44.7 44.6 54.7 63.5 75.7 74.0 59.5 256.3 16.01 Preliminary forecasted number of burglaries =SUMXMY2(B7:B20,C7:C20)/COUNT(B7:B20) =SQRT(C22) weights: All weights should add-up exactly to 1 the lower is the weight Most recent observation has the highest weight =B5*$C$6+B4*$C$5+B3*$C$4 =B6*$C$6+B5*$C$5+B4*$C$4 =B7*$C$6+B6*$C$5+B5*$C$4 : : : : : : : : : : The further away from the forecast period

To determine best weights and period (k) we can use forecast accuracy. MSE = Mean Square Error is a good measure for forecast accuracy. RMSE = is the square root of the MSE.
Data: Evens - Burglaries
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Weighted Moving Average

Actual wMA(k =3) Month Burgla rie s 100.00% 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 MSE = RMSE = 88 44 60 56 70 91 54 60 48 35 49 44 61 68 82 71 50 0.1 0.3 0.6 58.0 56.0 64.8 81.2 66.7 61.3 52.2 41.4 44.7 44.6 54.7 63.5 75.7 74.0 59.5 256.3 16.01

Tools / Solver Set Target Cell: Cell containing RMSE value Equal to: Min By Changing Cells: Cells containing weights Subject to constraints: Cell containing sum of the weight = 1 Options / (check) Assume Non-Negativity Solve ----- Keep Solver Solution ----- OK

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Weighted Moving Average

Actual wMA(k =3) Month Burgla rie s 100.00% 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 MSE = RMSE = 88 44 60 56 70 91 54 60 48 35 49 44 61 68 82 71 50 0.0285 0.2093 0.7622 57.5 56.5 66.8 85.6 62.2 59.6 50.7 38.4 46.0 44.8 57.1 65.8 78.5 73.2 55.3 250.6 15.83

Best weights for a given k (in this case 3) is determined by solver trough minimizing RMSE. Same procedure could be applied to models with different ks and the one with lowest RMSE could be considered as the model with best forecasting period.
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Moving Average Models

Months 50 51 52 53 54 55 56 57 58 59 Crime 48 35 49 44 61 68 82 71 50 #N/A #N/A 44.00 42.67 51.33 57.67 70.33 73.67 67.67 #N/A #N/A #N/A #N/A 6.33 8.21 10.59 9.13 12.32
Crimes

k=3

errors

Actual Forecast 90 80 70 60 50 40 30 20 10 0 50 51

Moving Average

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53

54 Months

55

56

57

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Tools/ Data Analysis / Moving Average

Input Range: Observations with title (No time) Output Range: Select next column to the input range and 1-Row below of the first observation Chart misaligns the forecasted values! Forecasted 59th month is aligned with 58th month 13

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Exponential Smoothing
Exponential smoothing is a time-series smoothing and forecasting technique that produces an exponentially weighted moving average in which each smoothing calculation or forecast is dependent upon all previously observed values. The smoothing factor is a value between 0 and 1, where closer to 1 means more weigh to the recent observations and hence more rapidly changing forecast.
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Exponential Smoothing Model

Ft Ft 1 ( Yt 1 Ft 1 )
Ft Yt 1 ( 1 )Ft 1
where: Ft= Forecast value for period t Yt-1 = Actual value for period t-1 Ft-1 = Forecast value for period t-1 = Alpha (smoothing constant)
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or

Exponential Smoothing Model

Month 50 51 52 53 54 55 56 57 58 59 Crimes 48 35 49 44 61 68 82 71 50 ? alpha=0.7 #N/A
Crimes
Actual Forecast 90 80 70 60 50 40 30 20 10 0 50 51 52 53 54 55 56 57 58 59

Expone ntial Smoothing

48.0 38.9 46.0 44.6 56.1 64.4 76.7 72.7 56.8

M onths

Tools/ Data Analysis / Exponential Smoothing.

Input Range: Observations with title (No time) Output Range: Select next column to the input range and first Row of the first observation Damping Factor: 1- (not ) Dr. C. Ertuna 16

Exponential Smoothing Model

A 1 2 3 4 5 6 7 8 9 10 11 12 13 B C D

Month Crime 50 51 52 53 54 55 56 57 58 59 48 35 49 44 61 68 82 71 50 ? MSE =

0.7 #N/A 48.00 ! Actual observation B2 38.90 45.97 44.59 56.08 64.42 76.73 72.72 56.82 =$C$1*B10+(1-$C$1)*C10 193.0 =SUMXMY2(B3:B10,C3:C10)/COUNT(B3:B10)

To determine best we can use forecast accuracy. MSE = Mean Square Error is a good measure for forecast accuracy.

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Holt-Winters Model
The Holt-Winters forecasting model could be used in forecasting trends. Holt-Winters model consists of both an exponentially smoothing component (E, w) and a trend component (T, v) with two different smoothing factors.

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Holt-Winters Model

Ft k E t kTt
where:

E t wYt 1 ( 1 w )( E t 1 Tt 1 ) Tt v ( E t E t 1 ) ( 1 v )Tt 1
Ft+k= Forecast value k periods from t 1. E and T are 1 1 Yt-1 = Actual value for period t-1 not defined. Et-1 = Estimated value for period t-1 2. E = Y 2 2 Tt = Trend for period t 3. T2 = Y2 Y1 w = Smoothing constant for estimates v = Smoothing factor for trend Dr. C. Ertuna 19 k = number of periods

Holt-Winters Model
A 1 2 Month 3 1 4 2 5 3 6 4 7 5 8 6 9 7 10 8 11 9 12 10 13 11 14 12 15 13 B C D E w= 0.7 0.5 = v Sales E T F 4.8 N/A N/A 4.0 4.0 -0.8 5.5 4.8 0.0 3.2 15.6 12.4 3.8 4.8 23.1 21.0 6.2 16.1 23.3 24.5 4.8 27.2 31.4 30.8 5.6 29.3 46.0 43.1 8.9 36.3 46.1 47.9 6.9 52.1 41.9 45.8 2.4 54.8 45.5 46.3 1.4 48.1 53.5 51.8 3.5 47.7 55.24
Holt-Winter Forecasting 60.0 50.0 40.0 30.0 20.0 10.0 0.0
1 2 3 4 5 6 7 8 9 10 11 12 13

Sales

Sales F

Months

E_2 = Y_2 and T_2 = (Y_2-Y_1) E_12 = $D$1*C14+(1-$D$1)*(D13+E13) T_12 = $E$1*(D14-D13)+(1-$E$1)*E13 Dr. F_13 = D14+E14 C. Ertuna 20

Holt-Winters Model
Set E (smoothing component), T (trend component), and F (forecasted values) columns next to Y (actual observations) in the same sequence Determine initial w and v values Leave E,T &F blanc for the base period (t=1) Set E2 = Y2 Set T2 = Y2-Y1 Note: (F2 is blanc)
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Holt-Winters Model
Formulate E3 = w*Y3 + (1-w)*(E2+T2) Formulate T3 = v*(E3-E2) + (1-v)*T2 Formulate F3 = E2 + T2 Copy the formulas down until reaching one cell further than the last observation (Yn). Compute MSE using Ys and Fs Use solver to determine optimal w and v.
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Holt-Winters Model
Solver set up for Holt Winters: Target Cell: MSE (min) Changing Cells: w and v Constrains: w <= 1 w >= 0 v <= 1 v >= 0
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Forecasting with Crystal Ball

CBTools / CB Predictor
[Input Data] Select
Range, First Raw, First Column Next

[Data Attribute] Data is in periods, etc. Next [Method Gallery] Select All Next [Results] Number of periods to forecast [1] Select Past Forecasts at cell Run
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Forecasting with Crystal Ball

Year Actual Revenue 1975 5.0 1976 5.4 1977 6.0 1978 7.0 1979 8.0 1980 9.7 1981 10.3 1982 10.8 1983 10.2 1984 10.6 1985 10.6 1986 11.5 1987 13.3 1988 17.0 1989 18.4 1990 18.9 1991 19.4 1992 20.2 1993 16.3 1994 13.7 1995 15.3 1996 16.2 1997 14.5 1998 13.4 1999 14.1 Actual Revenues of EASTMAN KODAC Data: EASTMANK

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Forecasting with Crystal Ball

Method Parameters: Method Best : Double Exponential Smoothing Alpha Beta 2nd: 3rd: 4th: Single Exponential Smoothing Single Moving Average Double Moving Average Alpha Periods Periods 0.999 0.051 2nd: 0.999 1 2 3rd: 4th:
Student Edition

Method Errors: Parameter Value Best : Method Double Exponential Smoothing Single Exponential Smoothing Single Moving Average Double Moving Average RMSE MAD MAPE

1.5043 1.5147 1.5453 2.0855

Actual Revenue

0.9871 1.1566 1.2042 1.592

7.68% 9.03% 9.40% 11.16%

Student Edition

Forecast: Date 2000 Lower: 5% 11.9 Forecast 14.4 Upper: 95%

25.0 20.0 Data 15.0 Fitted Forecast 10.0 5.0 0.0 Upper: 95% Low er: 5%

17.0

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19 77

19 79

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19 97

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Performance of a Model
Performance of a model is measured by Theils U. The Theil's U statistic falls between 0 and 1. When U = 0, that means that the predictive performance of the model is excellant and when U = 1 then it means that the forecasting performance is not better than just using the last actual observation as a forecast.
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Theils U versus RMSE

The difference between RMSE (or MAD or MAPE) and Theils U is that the formars are measure of fit; measuring how well model fits to the historical data. The Theil's U on the other hand measures how well the model predicts against a naive model. A forecast in a naive model is done by repeating the most recent value of the variable as the next forecasted value.
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Choosing Forecasting Model

The forecasting model should be the one with lowest Theils U. If the best Theils U model is not the same as the best RMSE model then you need to run CB again by checking only the best Theils U model to obtain forecasted value. P.S. CB uses forecasting value of the lowest RMSE model (best model according CB)!
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Determining Performance
Theils U determins the forecasting performance of the model. The interpretation in daily language is as follows:
Interpret (1- Theil U) 1.00 0.80 High (strong) forecasting power 0.80 0.60 Moderately high forecasting power 0.60 0.40 Moderate forecasting power 0.40 0.20 Weak forecasting power 0.20 0.00 Very weak forecasting power
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Regression or Time Series Forecast

Here is the guiding principle when to apply Regression and when to apply Time Series Forecast. As some thing changes (one or more independent variables) how does another thing (dependent variable) change is an issue of directional relationship For directional relationships we can use regression. If the independent variable is TIME (as time changes how does a variable change) Then we can use either regression or time series forecasting models
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Explanatory Methods
Simple Linear Regression Model: The simplest inferential forecasting model is the simple linear regression model, where time (t) is the independent variable and the least square line is used to forecast the future values of Yt.

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Regression in Forecasting Trends

Ft E ( Yt ) 0 1 t t
where:
Yt = Value of trend at time t 0 = Intercept of the trend line 1 = Slope of the trend line t = Time (t = 1, 2, . . . )
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Regression in Forecasting Seasonality

Many time series have distinct seasonal pattern. (For example room sales are usually highest around summer periods.) Multiple regression models can be used to forecast a time series with seasonal components. The use of dummy variables for seasonality is common.
Dummy variables needed = total number of seasonality 1 For example: Quarterly Seasonal: 3 Dummies are needed, Monthly Seasonal: 11 Dummies needed, etc. The load of each seasonal variable (dummy) is compared to the one which is hidden in intercept.
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Regression in Forecasting Seasonality

Ft E ( Yt ) 0 1 t 2 Q1 3Q2 4 Q3 t
where: Q1 = 1 , if quarter is 1, = 0 otherwise Q2 = 1 , if quarter is 2, = 0 otherwise Q3 = 1 , if quarter is 3, = 0 otherwise 2 = the load of Q1 above Q4 0 = the overall intercept + the load of Q4 t = Time (t = 1, 2, . . . )
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Seasonal Regression
MegaWatts Power Load 106.8 89.2 110.7 91.7 108.6 98.9 120.1 102.1 113.1 94.2 120.5 107.4 116.2 104.4 131.7 117.9
Seasonal Regression

Year Q1 Q2 Q3 1973.1 1 0 0 1973.2 0 2 0 1973.3 0 0 3 1973.4 0 0 0 1974.1 1 0 0 1974.2 0 2 0 1974.3 0 0 3 1974.4 0 0 0 1975.1 1 0 0 1975.2 0 2 0 1975.3 0 0 3 1975.4 0 0 0 1976.1 1 0 0 1976.2 0 2 0 1976.3 0 0 3 1976.4 0 0 0

135.00 130.00 125.00 120.00 115.00 110.00 105.00 100.00 95.00 90.00 85.00 80.00
19 73 .1 19 73 .2 19 73 .3 19 73 .4 19 74 .1 19 74 .2 19 74 .3 19 74 .4 19 75 .1 19 75 .2 19 75 .3 19 75 .4 19 76 .1 19 76 .2 19 76 .3 19 76 .4

Predicted Power Load Actual Power Load

Power

Year/Quarter

E(Y_Q1) = -10801.6 + 5.52 * Year.1 + 8.06

E(Y_Q2) = -10801.6 + 5.52 * Year.2 + -3.50

E(Y_Q3) = -10801.6 + 5.52 * Year.3 + 5.51 E(Y_Q4) = -10801.6 + 5.52 * Year.4
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Next Lesson

(Lesson - 09)

Introduction to Optimization

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