MGS3100 Chapter 13

Forecasting
Slides 13b:
Time-Series Models;
Measuring Forecast Error
 Forecasting Models
Forecasting
Techniques

Qualitative Time Series

Models Methods

Delphi
Naive
Method
Moving
Jury of Executive
Average
Opinion
Weighted
Sales Force
Moving Average
Composite
Exponential
Consumer Market
Smoothing
Survey

Trend Analysis
Causal
Methods
Seasonality
Simple Analysis
Regression
Analysis Multiplicative
Decomposition
Multiple
Regression
Analysis
 Time Series Models
 General Form: Y = T * C * S ± ε, where
• T = Trend - long term movement of mean
• C = (Business) Cycle - an upturn or downturn not caused
by seasonal variation; effect of the economy
• S = Seasonal Variation - repetitive pattern observed over
a specific time period
• ε = Error (random variation)

 Practical Forecast Form: Ŷ = T * S

• C is important, but difficult to forecast
• Don’t forecast an error!
 Components of a Time Series
Time
series
value Linear trend and seasonality time series

Future
Linear trend time series

A stationary time series

Time
 Time Series: Stationary Models
 Stationary Model Assumptions
• Assumes item forecasted will stay steady over time (constant
mean; random variation only)
• Techniques will smooth out short-term irregularities
• Forecast for period t+1 is equal to forecast for period t+k; the
forecast is revised only when new data becomes available.
 Stationary Model Types
• Naïve Forecast
• Moving Average
• Weighted Moving Average
• Exponential Smoothing
 Stationary Time Series Models:
The Naïve Model
 Whatever happened
last period will
happen again this time
 The model is simple Ft  Yt 1
and flexible
 Provides a baseline to or
measure other models
 Attempts to capture Ft  Yt  4 : Quarterly data
seasonal factors at the Ft  Yt 12 : Monthly data
expense of ignoring
trend
 Measures of Forecast Error
( Forecast Error  Yt  Ft )
T
• Bias - The arithmetic sum of the
errors Bias   (forecast error) /T
t 1
• MAD - Mean Absolute Deviation T
• MAPE – Mean Absolute Percentage   (Yt  Ft ) / T
Error t 1
• Mean Square Error (MSE) - Similar T
to simple sample variance MSE   | forecast error |2 /T
• Standard Error - Standard deviation t 1
of the sampling distribution (the T
square   (Yt  Ft ) 2 / T
root of the MSE) t 1
• Bias, MAD, and MAPE - typically T T
used for time series MAD   | forecast
t 1
error | /T   |Yt  Ft | / T
t 1

T
MAPE  100 [|Yt  Ft | / Yt ] / T
t 1
 Naïve Forecast
Wallace Garden Supply
Forecasting
Storage Shed Sales

Actual Naïve Absolute Percent Squared

Period Value Forecast Error Error Error Error
January 10 N/A
February 12 10 2 2 16.67% 4.0
March 16 12 4 4 25.00% 16.0
April 13 16 -3 3 23.08% 9.0
May 17 13 4 4 23.53% 16.0
June 19 17 2 2 10.53% 4.0
July 15 19 -4 4 26.67% 16.0
August 20 15 5 5 25.00% 25.0
September 22 20 2 2 9.09% 4.0
October 19 22 -3 3 15.79% 9.0
November 21 19 2 2 9.52% 4.0
December 19 21 -2 2 10.53% 4.0
0.818 3 17.76% 10.091
BIAS MAD MAPE MSE

Standard Error (Square Root of MSE) = 3.176619

 Naïve Forecast Graph
Wallace Garden - Naive Forecast

25

20

15
Actual Value
Sheds

Naïve Forecast
10

0
February March April May June July August September October November December
Period
Stationary Time Series Models:
Moving Averages

The Moving Average Method

 The forecast is the average of the last n
observations of the time series.

YYtt YYtt11 ...

...YYttnn11
FFtt11 
nn
 Moving Averages
Wallace Garden Supply
Forecasting
Storage Shed Sales

Actual
Period Value Three-Month Moving Averages
January 10
February 12
March 16
April 13 10 + 12 + 16 / 3 = 12.67
May 17 12 + 16 + 13 / 3 = 13.67
June 19 16 + 13 + 17 / 3 = 15.33
July 15 13 + 17 + 19 / 3 = 16.33
August 20 17 + 19 + 15 / 3 = 17.00
September 22 19 + 15 + 20 / 3 = 18.00
October 19 15 + 20 + 22 / 3 = 19.00
November 21 20 + 22 + 19 / 3 = 20.33
December 19 22 + 19 + 21 / 3 = 20.67
 Moving Averages Forecast
Wallace Garden Supply
Forecasting 3 period moving average
Actual Value - Forecast

Input Data Forecast Error Analysis

Absolute Squared Absolute
Period Actual Value Forecast Error error error % error
Month 1 10
Month 2 12
Month 3 16
Month 4 13 12.667 0.333 0.333 0.111 2.56%
Month 5 17 13.667 3.333 3.333 11.111 19.61%
Month 6 19 15.333 3.667 3.667 13.444 19.30%
Month 7 15 16.333 -1.333 1.333 1.778 8.89%
Month 8 20 17.000 3.000 3.000 9.000 15.00%
Month 9 22 18.000 4.000 4.000 16.000 18.18%
Month 10 19 19.000 0.000 0.000 0.000 0.00%
Month 11 21 20.333 0.667 0.667 0.444 3.17%
Month 12 19 20.667 -1.667 1.667 2.778 8.77%
Average 1.333 2.000 6.074 10.61%
Next period 19.667 BIAS MAD MSE MAPE
 Moving Averages Graph
Three Period Moving Average

25

20

15

Actual Value
Value

Forecast

10

0
1 2 3 4 5 6 7 8 9 10 11 12
Time
 Stability vs. Responsiveness
• Should I use a 2-period moving average or
a 3-period moving average?
– The larger the “n” the more stable the forecast.
– A 2-period model will be more responsive to
change.
– We don’t want to chase outliers.
– But we don’t want to take forever to correct for
a real change.
– We must balance stability with responsiveness.
 Stationary Time Series Models:
Weighted Moving Averages
• The Weighted Moving Average Method
– Historical values of the time series are assigned
different weights when performing the forecast

Ft 1 = w1Yt + w2Yt-1 +w3Yt-2 + …+ wnYt-n+1

wi = 1
 Weighted Moving
Wallace Garden Supply
Average
Forecasting
Storage Shed Sales

Actual
Period Value Weights Three-Month Weighted Moving Averages
January 10 0.222
February 12 0.593
March 16 0.185
April 13 2.2 + 7.1 + 3 / 1 = 12.298
May 17 2.7 + 9.5 + 2.4 / 1 = 14.556
June 19 3.5 + 7.7 + 3.2 / 1 = 14.407
July 15 2.9 + 10 + 3.5 / 1 = 16.484
August 20 3.8 + 11 + 2.8 / 1 = 17.814
September 22 4.2 + 8.9 + 3.7 / 1 = 16.815
October 19 3.3 + 12 + 4.1 / 1 = 19.262
November 21 4.4 + 13 + 3.5 / 1 = 21.000
December 19 4.9 + 11 + 3.9 / 1 = 20.036

Next period 20.185

Sum of weights = 1.000

 Weighted Moving Average
Wallace Garden Supply
Forecasting 3 period weighted moving average

Input Data Forecast Error Analysis

Absolute Squared Absolute
Period Actual value Weights Forecast Error error error % error
Month 1 10 0.222
Month 2 12 0.593
Month 3 16 0.185
Month 4 13 12.298 0.702 0.702 0.492 5.40%
Month 5 17 14.556 2.444 2.444 5.971 14.37%
Month 6 19 14.407 4.593 4.593 21.093 24.17%
Month 7 15 16.484 -1.484 1.484 2.202 9.89%
Month 8 20 17.814 2.186 2.186 4.776 10.93%
Month 9 22 16.815 5.185 5.185 26.889 23.57%
Month 10 19 19.262 -0.262 0.262 0.069 1.38%
Month 11 21 21.000 0.000 0.000 0.000 0.00%
Month 12 19 20.036 -1.036 1.036 1.074 5.45%
Average 1.988 6.952 6.952 10.57%
Next period 20.185 BIAS MAD MSE MAPE

Sum of weights = 1.000

 Stationary Time Series Models:
Exponential Smoothing
– Exponential Smoothing
• Moving average technique that requires a minimum
amount of past data
• Uses a smoothing constant α with a value between 0 and 1
(Usual range 0.1 to 0.3)
• Forecast for period t = Forecast for period t-1 plus α times
the difference between the actual value and forecast in
period t-1: Ŷt = Ŷt-1 + α(Yt-1 - Ŷt-1), or
• Can also be expressed as: Ŷt = α(Yt-1) + (1- α)(Ŷt-1) =
α(Actual value in period t-1) + (1- α)(Forecast in period t-1)
 Exponential Smoothing Data
Storage Shed Sales

Actual
Period Value(Yt ) Ŷ t-1 α Y t-1 Ŷt-1 Ŷt
January 10 = 10 0.1
February 12 10 + 0.1 *( 10 - 10 )= 10.000
March 16 10 + 0.1 *( 12 - 10 )= 10.200
April 13 10.2 + 0.1 *( 16 - 10.2 )= 10.780
May 17 10.78 + 0.1 *( 13 - 10.78 )= 11.002
June 19 11.002 + 0.1 *( 17 - 11.002 )= 11.602
July 15 11.602 + 0.1 *( 19 - 11.602 )= 12.342
August 20 12.342 + 0.1 *( 15 - 12.342 )= 12.607
September 22 12.607 + 0.1 *( 20 - 12.607 )= 13.347
October 19 13.347 + 0.1 *( 22 - 13.347 )= 14.212
November 21 14.212 + 0.1 *( 19 - 14.212 )= 14.691
December 19 14.691 + 0.1 *( 21 - 14.691 )= 15.322

Class Exercise: What is the forecast for January of the following year?
How about March? Find the Bias, Mad & MAPE. (Note: α equals 0.1.)
 Exponential Smoothing
(Alpha = .419)
Wallace Garden Supply
Forecasting Exponential smoothing

Input Data Forecast Error Analysis

Absolute Squared Absolute
Period Actual value Forecast Error error error % error
Month 1 10 10.000
Month 2 12 10.000 2.000 2.000 4.000 16.67%
Month 3 16 10.838 5.162 5.162 26.649 32.26%
Month 4 13 13.000 0.000 0.000 0.000 0.00%
Month 5 17 13.000 4.000 4.000 16.000 23.53%
Month 6 19 14.675 4.325 4.325 18.702 22.76%
Month 7 15 16.487 -1.487 1.487 2.211 9.91%
Month 8 20 15.864 4.136 4.136 17.106 20.68%
Month 9 22 17.596 4.404 4.404 19.391 20.02%
Month 10 19 19.441 -0.441 0.441 0.194 2.32%
Month 11 21 19.256 1.744 1.744 3.041 8.30%
Month 12 19 19.987 -0.987 0.987 0.973 5.19%
Average 2.608 9.842 14.70%
Alpha 0.419 MAD MSE MAPE

Next period 19.573

 Exponential Smoothing
Exponential Smoothing

25

20

15
Sh ed s

Actual value
Forecast

10

0
 Evaluating the Performance
of Forecasting Techniques

• Several forecasting methods have been

presented.

• Which one of these forecasting methods

gives the “best” forecast?
 Performance Measures –
Sample Example
• Find the forecasts and the errors for each forecasting
technique applied to the following stationary time series.

Time 1 2 3 4 5 6
Time series: 100 110 90 80 105 115
3-Period Moving average: 100 93.33 91.6
Error for the 3-Period MA: - 20 11.67 23.4
3-Period Weighted MA(.5, .3, .2) 98 89 85.5
Error for the 3-Period WMA - 18 16 29.5
 Performance Measures –
MAD for the Sample Example

MAD for the moving average technique:

MAD =
 t| = |-20| + |11.67| + |23.4|
= 18.35
n 3

MAD for the weighted moving average technique:

MAD =
 t| = |-18| + |116| + |29.5| = 21.17
n 3
 Performance Measures –
MAPE for the Sample Example

MAPE for the moving average technique:

 t| |-20|/80 + |11.67|/105+ |23.4|/115

MAPE= = = .188
n 3

MAPE for the weighted moving average technique:

 t| |-18|/80 + |16|/105 + |29.5|/115

MAPE= = = .211
n 3
 Performance Measures –
Selecting Model Parameters
• Use the performance measures to select a good set of
values for each model parameter.
– For the moving average:
• the number of periods (n).
– For the weighted moving average:
• The number of periods (n),
• The weights (wi).
– For the exponential smoothing:
• The exponential smoothing factor ().
• Excel Solver can be used to determine the values of
the model parameters.
 Trend & Seasonality
• Trend analysis
– Technique that fits a trend equation (or curve) to a series of
historical data points
– Projects the equation into the future for medium and long
term forecasts. Typically do not want to forecast into the
future more than half the number of time periods used to
generate the forecast
• Seasonality analysis
– Adjustment to time series data due to variations at certain
periods.
– Adjust with seasonal index - ratio of average value of the
item in a season to the overall annual average value.
– Examples: demand for coal in winter months; demand for
soft drinks in the summer and over major holidays
 Linear Trend Analysis
Midwestern Manufacturing Sales

Sales(in units) vs. Time

Scatter Diagram 160

Actual Period 140

value (or) number
Y (or) X 120
74 1995
79 1996 100
80 1997
90 1998 80
105 1999
142 2000 60
122 2001
40
20
0
1994 1995 1996 1997 1998 1999 2000 2001 2002
 Least Squares for Linear Regression
Midwestern Manufacturing
Least Squares Method
Values of Dependent Variables

Objective: Minimize
the squared deviations!

Time
 Least Squares Method
Where
^
Y  a  bX
^
Y = predicted value of the dependent variable (demand)

X = value of the independent variable (time)

a = Y-axis intercept = Y - b* X _ _
[ XY - n X Y ]
b = Slope of the regression line =
 _
2

2
X - n X 
 
 Linear Trend Data & Error Analysis
Midwestern Manufacturing Company
Forecasting Linear trend analysis
Enter the actual values in cells shaded YELLOW. Enter new time period at the bottom to forecast

Input Data Forecast Error Analysis

Actual value Period number Absolute Squared Absolute
Period (or) Y (or) X Forecast Error error error % error
Year 1 74 1 67.250 6.750 6.750 45.563 9.12%
Year 2 79 2 77.786 1.214 1.214 1.474 1.54%
Year 3 80 3 88.321 -8.321 8.321 69.246 10.40%
Year 4 90 4 98.857 -8.857 8.857 78.449 9.84%
Year 5 105 5 109.393 -4.393 4.393 19.297 4.18%
Year 6 142 6 119.929 22.071 22.071 487.148 15.54%
Year 7 122 7 130.464 -8.464 8.464 71.644 6.94%
Average 8.582 110.403 8.22%
Intercept 56.714 MAD MSE MAPE
Slope 10.536

Next period 141.000 8

 Least Squares Graph
Tre nd Analysis

160

140

y = 10.536x + 56.714
120

100
Va lue

80

60

40

20

0
1 2 3 4 5 6 7
Time

Actual values Linear (Actual values)

 Another way to Determine Trend:
Use the Excel Regression Function
• Run linear regression to test 1 in the model Yt=0+1t+t
• Excel results:

Coeff. Stand. Err t-Stat P-value Lower 95%Upper 95%

Intercept 369.27 27.79436 13.2857 5E-18 313.44 425.094
Weeks 0.3339 0.912641 0.36586 0.71601
0.71601 -1.49919 2.16699

This large P-value indicates

that there is little evidence that trend exists

• Conclusion: A stationary model is appropriate.

Forecasting Seasonal Data: Quick Method
Eichler Supplies Ratio = Demand / Average Demand
Average Seasonal
Year Month Demand Demand Ratio Index
1 January 80 94 0.851 0.957
February 75 94 0.798 0.851
Seasonal Index – ratio of the
March 80 94 0.851 0.904 average value of the item in a
April 90 94 0.957 1.064 season to the overall average
May 115 94 1.223 1.309
June 110 94 1.170 1.223 annual value.
July 100 94 1.064 1.117
August 90 94 0.957 1.064 Example: average of year 1
September 85 94 0.904 0.957
October 75 94 0.798 0.851 January ratio to year 2 January
November 75 94 0.798 0.851 ratio.
December 80 94 0.851 0.851
(0.851 + 1.064)/2 = 0.957
2 January 100 94 1.064 0.957
February 85 94 0.904 0.851
March 90 94 0.957 0.904
April 110 94 1.170 1.064
If Year 3 average monthly demand is
May 131 94 1.394 1.309
June 120 94 1.277 1.223 expected to be 100 units.
July 110 94 1.170 1.117 Forecast demand Year 3 January:
August 110 94 1.170 1.064 100 X 0.957 = 96 units
September 95 94 1.011 0.957 Forecast demand Year 3 May:
October 85 94 0.904 0.851
November 85 94 0.904 0.851
100 X 1.309 = 131 units
December 80 94 0.851 0.851
 Forecasting Seasonal Data With Trend

1. Calculate the seasonal indices (as shown on the

previous slide)
2. Calculate “deseasonalized” treand by dividing the
actual value (Y) by the seasonal index for that
period:
Deseasonalized Trend = Y / Seasonal index
(e.g., 80 units/ 0.957 =
83.595)
3. Find the trend line, and extend the trend line into
the desired forecast period.
Forecasting Seasonal Data With Trend:
Calculating the Seasonal Forecast

4. Now that we have the Seasonal Indices and Trend

line, we can reseasonalize the data and generate
the “seasonalized” forecast by multiplying the
trend line values in the forecast period by the
appropriate seasonal indices for each time period
as follows:

Ŷ = Trend x Seasonal Index