2000 Prentice-Hall, Inc. Chap.

11- 1
The Least Squares
Linear Trend Model
Year Coded X Sales
95 0 2
96 1 5
97 2 2
98 3 2
99 4 7
00 5 6
0 1 i i
Y b b X = +
2000 Prentice-Hall, Inc. Chap. 11- 2
The Least Squares
Linear Trend Model
(Continued)
i i i
X . . X b b Y

743 143 2
1 0
+ = + =
Excel Output
Coeffi ci ents
I n te r ce p t 2. 14285714
X V a r i a b l e 1 0. 74285714
0
1
2
3
4
5
6
7
8
0 1 2 3 4 5 6
X
S
a
l
e
s
Projected to
year 2001
2000 Prentice-Hall, Inc. Chap. 11- 3
Year Coded X Sales
95 0 2
96 1 5
97 2 2
98 3 2
99 4 7
00 5 6
The Quadratic Trend
Model
2
0 1 2
i
i i
Y b b X b X = + +
2000 Prentice-Hall, Inc. Chap. 11- 4
The Quadratic Trend
Model
(Continued)
2 2
0 1 2
2.857 .33 .214
i
i i i i
Y b b X b X X X = + + = +
Coefficients
I nte rce pt 2. 85714286
X V a ri a bl e 1 -0. 3285714
X V a ri a bl e 2 0. 21428571
Excel Output
0
1
2
3
4
5
6
7
8
0 1 2 3 4 5 6

X
S
a
l
e
s
2000 Prentice-Hall, Inc. Chap. 11- 5
C o e f f i c i e n t s
In t e r c e p t 0 . 3 3 5 8 3 7 9 5
X V a r i a b l e 10 . 0 8 0 6 8 5 4 4
The Exponential Trend
Model
i
X
i
b b Y

1 0
=
or
1 1 0
b log X b log Y

log
i
+ =
Excel Output of Values in logs
i
X
i
) . )( . ( Y

2 1 17 2 =
Year Coded Sales
94 0 2
95 1 5
96 2 2
97 3 2
98 4 7
99 5 6
a n t i l o g (. 3 3 5 8 3 7 9 5 ) = 2 . 1 7
a n t i l o g (. 0 8 0 6 8 5 4 4 ) = 1 . 2
2000 Prentice-Hall, Inc. Chap. 11- 6
Model Selection Using
Differences
Use a Linear Trend Model if the First
Differences Are More or Less Constant


Use a Quadratic Trend Model if the
Second Differences Are More or Less
Constant
2 1 3 2 1 n n
Y Y Y Y Y Y

= = --- =
( ) ( ) ( ) ( )
3 2 2 1 1 1 2 n n n n
Y Y Y Y Y Y Y Y

= --- = ( (

2000 Prentice-Hall, Inc. Chap. 11- 7
Model Selection Using
Differences
Use an Exponential Trend Model if the
Percentage Differences Are More or
Less Constant
3 2 1 2 1
1 2 1
100% 100% 100%
n n
n
Y Y Y Y Y Y
Y Y Y

| | | | | |

= = --- =
| | |
\ . \ . \ .
(continued)
2000 Prentice-Hall, Inc. Chap. 11- 8
Autoregressive Modeling
Used for forecasting
Takes advantage of autocorrelation
1st order - correlation between consecutive
values
2nd order - correlation between values 2
periods apart
Autoregressive model for pth order:
i p i p i i i
Y A Y A Y A A Y o + + - - - + + + =
2 2 1 1 0
Random
Error
2000 Prentice-Hall, Inc. Chap. 11- 9
Autoregressive Model:
Example
The Office Concept Corp. has acquired a number of office
units (in thousands of square feet) over the last 8 years.
Develop the 2nd order Autoregressive model.
Year Units
93 4
94 3
95 2
96 3
97 2
98 2
99 4
00 6
2000 Prentice-Hall, Inc. Chap. 11- 10
Autoregressive Model:
Example Solution
Year Y
i
Y
i-1
Y
i-2

93 4 --- ---
94 3 4 ---
95 2 3 4
96 3 2 3
97 2 3 2
98 2 2 3
99 4 2 2
00 6 4 2
Coefficients
I nte rce pt 3. 5
X V a ri a bl e 1 0. 8125
X V a ri a bl e 2 -0. 9375
Excel Output
2 1
9375 8125 5 3

+ =
i i i
Y . Y . . Y
Develop the 2nd order
table
Use Excel to run a
regression model
2000 Prentice-Hall, Inc. Chap. 11- 11
Autoregressive Model Example:
Forecasting
Use the 2nd order model to forecast number of
units for 2001:
2001 2000 1999
3.5 .8125 .9375 Y Y Y = +
3.5 .8125 6 .9375 4 = +
4.625 =
1 2
3.5 .8125 .9375
i i i
Y Y Y

= +
2000 Prentice-Hall, Inc. Chap. 11- 12
Autoregressive Modeling
Steps
1. Choose p: note that df = n - p - 1
2. Form a series of lag predictor variables
Y
i-1
, y
i-2
, y
i-p
3. Use excel to run regression model using all p
variables
4. Test significance of a
p
If null hypothesis rejected, this model is
selected
If null hypothesis not rejected, decrease p by 1
and repeat

2000 Prentice-Hall, Inc. Chap. 11- 13
Selecting A Forecasting
Model
Perform A residual analysis
Look for pattern or direction
Measure sum of square error - SSE
(residual errors)
Measure residual error using MAD
Use simplest model
Principle of parsimony
2000 Prentice-Hall, Inc. Chap. 11- 14
Residual Analysis
Random errors
Trend not accounted for
Cyclical effects not accounted for
Seasonal effects not accounted for
T
T
T
T
e e
e
e
0 0
0 0
2000 Prentice-Hall, Inc. Chap. 11- 15
Measuring Errors
Choose a model that gives the smallest
measuring errors
Sum square error (SSE)
Sensitive to outliers

( )
2
1
n
i
i
i
SSE Y Y
=
=

2000 Prentice-Hall, Inc. Chap. 11- 16

Measuring Errors
Mean absolute deviation (MAD)
Not sensitive to extreme observations

1
n
i
i
i
Y Y
MAD
n
=

=

(continued)
2000 Prentice-Hall, Inc. Chap. 11- 17
Principal of Parsimony
Suppose 2 or more models provide
good fit for data
Select the simplest model
Simplest model types:
Least-squares linear
Least-square quadratic
1st order autoregressive
More complex types:
2nd and 3rd order autoregressive
Least-squares exponential
2000 Prentice-Hall, Inc. Chap. 11- 18
Forecasting With
Seasonal Data
Use categorical predictor variables with least-
square trending fitting
Exponential model with quarterly data:


The b
i
provides the multiplier for the ith quarter
relative to the 4th quarter
Q
i
= 1 if ith quarter and 0 if not
X
j
= the coded variable denoting the time period

3 2 1
4 3 2 1 0
Q Q Q X
b b b b b Y

i
2000 Prentice-Hall, Inc. Chap. 11- 19
Forecasting With Quarterly
Data: Example
4 4 5 . 7 7
4 4 4 . 2 7
4 6 2 . 6 9
4 5 9 . 2 7
5 0 0 . 7 1
5 4 4 . 7 5
5 8 4 . 4 1
6 1 5 . 9 3
6 4 5 . 5
6 7 0 . 6 3
6 8 7 . 3 1
7 4 0 . 7 4
7 5 7 . 1 2
8 8 5 . 1 4
9 4 7 . 2 8
9 7 0 . 4 3
I
2
3
4
Quarter 1994 1995 1996 1997
Standards and Poors Composite Stock Price Index:
Regression Statistics
Mul ti pl e R 0. 99005245
R Squa re 0. 980203854
Adj uste d R Squa re 0. 973005256
Sta nda rd Error 0. 04361558
Obse rva ti ons 16
Excel Output
Appears to be
an excellent fit.
r
2
is .98
2000 Prentice-Hall, Inc. Chap. 11- 20
Quarterly Data:
Example
Coefficients
Intercept 6.029403386
X Variable (Trend) 0.055222261
X Variable (Q1) -0.006892656
X Variable (Q2) 0.011566505
X Variable (Q3) -0.019380022
Excel Output
2 1 1 0
b ln Q b ln X b ln Y

ln
i i
+ + =
Regression Equation for the first quarter:
1
0069 055 029 6 Q . X . .
i
+ =
2000 Prentice-Hall, Inc. Chap. 11- 21
Chapter Summary
Discussed the importance of forecasting
Addressed component factors of the time-
series model
Performed smoothing of data series
Moving averages
Exponential smoothing
2000 Prentice-Hall, Inc. Chap. 11- 22
Chapter Summary
Described least square trend fitting and
forecasting
Linear, quadratic and exponential models
Addressed autoregressive models
Described procedure for choosing
appropriate models
Discussed seasonal data (use of dummy
variables)
(continued)