Chap19 Time-Series Analysis and Forecasting

Chap 19-1 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.
Chapter 19

Time-Series Analysis and
Forecasting
Statistics for
Business and Economics
6
th
Edition
Statistics for Business and Economics, 6e 2007 Pearson Education, Inc. Chap 19-2
Chapter Goals
After completing this chapter, you should be able to:
Compute and interpret index numbers
Weighted and unweighted price index
Weighted quantity index
Test for randomness in a time series
Identify the trend, seasonality, cyclical, and irregular
components in a time series
Use smoothing-based forecasting models, including
moving average and exponential smoothing
Apply autoregressive models and autoregressive
integrated moving average models
Index Numbers
Index numbers allow relative comparisons
over time
Index numbers are reported relative to a Base
Period Index
Base period index = 100 by definition
Used for an individual item or measurement
Consider observations over time on the price of a single
item
To form a price index, one time period is chosen as a
base, and the price for every period is expressed as a
percentage of the base period price
Let p
0
denote the price in the base period
Let p
1
be the price in a second period
The price index for this second period is
|
|
.
|
\
|
0
1
p
p
100
Single Item Price Index
Index Numbers: Example
Airplane ticket prices from 1995 to 2003:
90
320
288
(100)
P
P
100 I
2000
1996
1996
= = =

Year

Price
Index
(base year
= 2000)
1995 272 85.0
1996 288 90.0
1997 295 92.2
1998 311 97.2
1999 322 100.6
2000 320 100.0
2001 348 108.8
2002 366 114.4
2003 384 120.0
100
320
320
(100)
P
P
100 I
2000
2000
2000
= = =
120
320
384
(100)
P
P
100 I
2000
2003
2003
= = =
Base Year:
Prices in 1996 were 90%
of base year prices

of base year prices (by
definition, since 2000 is the
base year)

of base year prices
Index Numbers: Interpretation
90 ) 100 (
320
288
100
P
P
I
2000
1996
1996
= = =
100 ) 100 (
320
320
100
P
P
I
2000
2000
2000
= = =
120 ) 100 (
320
384
100
P
P
I
2000
2003
2003
= = =
Aggregate Price Indexes
An aggregate index is used to measure the rate
of change from a base period for a group of items
Aggregate
Price Indexes
Unweighted
aggregate
price index
Weighted
aggregate
price indexes
Laspeyres Index
Unweighted
Aggregate Price Index
Unweighted aggregate price index for period
t for a group of K items:
|
|
|
|
.
|
\
|
=
=
K
1 i
0i
K
1 i
ti
p
p
100
= sum of the prices for the group of items at time t
= sum of the prices for the group of items in time period 0
i = item
t = time period
K = total number of items
=
=
K
1 i
0i
K
1 i
ti
p
p
Unweighted total expenses were 18.8%
higher in 2004 than in 2001
Automobile Expenses:
Monthly Amounts ($):
Year Lease payment Fuel Repair
Total
Index
(2001=100)
2001 260 45 40 345 100.0
2002 280 60 40 380 110.1
2003 305 55 45 405 117.4
2004 310 50 50 410 118.8
Unweighted Aggregate Price
Index: Example
118.8
345
410
(100)
P
P
100 I
2001
2004
2004
= = =
Weighted
Aggregate Price Indexes
A weighted index weights the individual prices by
some measure of the quantity sold
If the weights are based on base period quantities the
index is called a Laspeyres price index
The Laspeyres price index for period t is the total cost of
purchasing the quantities traded in the base period at prices in
period t , expressed as a percentage of the total cost of
purchasing these same quantities in the base period
The Laspeyres quantity index for period t is the total cost of the
quantities traded in period t , based on the base period prices,
expressed as a percentage of the total cost of the base period
quantities

Laspeyres Price Index
= quantity of item i purchased in period 0

= price of item i in time period 0
= price of item i in period t
Laspeyres price index for time period t:
0i
q
|
|
|
|
.
|
\
|
=
=
K
1 i
0i 0i
K
1 i
ti 0i
p q
p q
100
ti
0i
p
p
Laspeyres Quantity Index
|
|
|
|
.
|
\
|
=
=
K
1 i
0i 0i
K
1 i
0i ti
p q
p q
100
= price of item i in period 0

= quantity of item i in time period 0
= quantity of item i in period t
Laspeyres quantity index for time period t:
ti
0i
q
q
0i
p
The Runs Test for Randomness
The runs test is used to determine whether a
pattern in time series data is random
A run is a sequence of one or more
occurrences above or below the median
Denote observations above the median with +
signs and observations below the median with
- signs

Consider n time series observations
Let R denote the number of runs in the
sequence
The null hypothesis is that the series is random
Appendix Table 14 gives the smallest
significance level for which the null hypothesis
can be rejected (against the alternative of
positive association between adjacent
observations) as a function of R and n
(continued)
If the alternative is a two-sided hypothesis on
nonrandomness,
the significance level must be doubled if it is
less than 0.5
if the significance level, o, read from the table
is greater than 0.5, the appropriate
significance level for the test against the two-
sided alternative is 2(1 - o)
(continued)
Counting Runs
Sales
Time
- - + - - + + + + - - - - - + + + +
Runs: 1 2 3 4 5 6
n = 18 and there are R = 6 runs
Median
Runs Test Example
Use Appendix Table 14
n = 18 and R = 6
the null hypothesis can be rejected (against the
alternative of positive association between adjacent
observations) at the 0.044 level of significance
Therefore we reject that this time series is random
using o = 0.05
n = 18 and there are R = 6 runs
Runs Test: Large Samples
Given n > 20 observations
Let R be the number of sequences above or below
the median

Consider the null hypothesis H
0
: The series is random

If the alternative hypothesis is positive association
between adjacent observations, the decision rule is:
2
0
z
1) 4(n
2n n
1
2
n
R
z if H Reject <

=
Runs Test: Large Samples
Consider the null hypothesis H
0
: The series is random

If the alternative is a two-sided hypothesis of
nonrandomness, the decision rule is:
/2
2
/2
2
0
z
1) 4(n
2n n
1
2
n
R
z or z
1) 4(n
2n n
1
2
n
R
z if H Reject >

= <

=
(continued)
Example: Large Sample
Runs Test
A filling process over- or under-fills packages,
compared to the median
OOO U OO U O UU OO UU OOOO UU O UU
OOO UUU OOOO UU OO UUU O U OO UUUUU
OOO U O UU OOO U OOOO UUU O UU OOO U
OO UU O U OO UUU O UU OOOO UUU OOO
n = 100 (53 overfilled, 47 underfilled)
R = 45 runs
Runs Test
A filling process over- or under-fills packages,
compared to the median
n = 100 , R = 45
1.206
4.975
6
1) 4(100
2(100) 100
1
2
100
45
1) 4(n
2n n
1
2
n
R
Z
2 2
=

=
(continued)
1.96 0
Rejection Region
o/2 = 0.025
Since z = -1.206 is not less than -z
.025
= -1.96,
we do not reject H
0

1.96
Rejection Region
o/2 = 0.025
H
0
: Fill amounts are random
H
1
: Fill amounts are not random
Test using o = 0.05
Runs Test
(continued)
Time-Series Data
Numerical data ordered over time
The time intervals can be annually, quarterly,
daily, hourly, etc.
The sequence of the observations is important
Example:
Year: 2001 2002 2003 2004 2005
Sales: 75.3 74.2 78.5 79.7 80.2

Time-Series Plot
the vertical axis
measures the variable
of interest

the horizontal axis
corresponds to the
time periods
U.S. Inflation Rate
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
1
9
7
5
1
9
7
7
1
9
7
9
1
9
8
1
1
9
8
3
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
1
9
9
9
2
0
0
1
Year
I
n
f
l
a
t
i
o
n

R
a
t
e

(
%
)
A time-series plot is a two-dimensional
plot of time series data
Time-Series Components
Time Series
Cyclical
Component
Irregular
Component
Trend
Component
Seasonality
Component
Trend Component
Long-run increase or decrease over time
(overall upward or downward movement)
Data taken over a long period of time
Sales
Time
Downward linear trend
Trend Component
Trend can be upward or downward
Trend can be linear or non-linear
Sales
Time
Upward nonlinear trend
Sales
Time
(continued)
Seasonal Component
Short-term regular wave-like patterns
Observed within 1 year
Often monthly or quarterly
Sales
Time (Quarterly)
Winter
Spring
Summer
Fall
Winter
Spring
Summer
Fall
Cyclical Component
Long-term wave-like patterns
Regularly occur but may vary in length
Often measured peak to peak or trough to
trough
Sales
1 Cycle
Year
Irregular Component
Unpredictable, random, residual fluctuations
Due to random variations of
Nature
Accidents or unusual events
Noise in the time series
Time-Series Component Analysis
Used primarily for forecasting
Observed value in time series is the sum or product of
components
Additive Model

Multiplicative model (linear in log form)
where T
t
= Trend value at period t
S
t
= Seasonality value for period t
C
t
= Cyclical value at time t
I
t
= Irregular (random) value for period t
t t t t t
I C S T X + + =
t t t t t
I C S T X =
Smoothing the Time Series
Calculate moving averages to get an overall
impression of the pattern of movement over
time
This smooths out the irregular component

Moving Average: averages of a designated
number of consecutive
time series values
(2m+1)-Point Moving Average
A series of arithmetic means over time
Result depends upon choice of m (the
number of data values in each average)
Examples:
For a 5 year moving average, m = 2
For a 7 year moving average, m = 3
Etc.
Replace each x
t
with
=
+
+ + =
+
=
m
m j
j t
*
t
m) n , 2, m 1, m (t X
1 2m
1
X
Moving Averages
Example: Five-year moving average

First average:

Second average:

etc.
5
x x x x x
x
5 4 3 2 1
*
5
+ + + +
=
5
x x x x x
x
6 5 4 3 2
*
6
+ + + +
=
Example: Annual Data
Year Sales
1
2
3
4
5
6
7
8
9
10
11
etc
23
40
25
27
32
48
33
37
37
50
40
etc
Annual Sales
0
10
20
30
40
50
60
1 2 3 4 5 6 7 8 9 10 11
Year
S
a
l
e
s

Calculating Moving Averages
Each moving average is for a
consecutive block of (2m+1) years
Year Sales
1 23
2 40
3 25
4 27
5 32
6 48
7 33
8 37
9 37
10 50
11 40
Average
Year
5-Year
Moving
Average
3 29.4
4 34.4
5 33.0
6 35.4
7 37.4
8 41.0
9 39.4

5
32 27 25 40 23
29.4
+ + + +
=
etc
Let m = 2
Annual vs. 5-Year Moving Average
0
10
20
30
40
50
60
1 2 3 4 5 6 7 8 9 10 11
Year
S
a
l
e
s
Annual 5-Year Moving Average
Annual vs. Moving Average
The 5-year
moving average
smoothes the
data and shows
the underlying
trend
Centered Moving Averages
Let the time series have period s, where s is
even number
i.e., s = 4 for quarterly data and s = 12 for monthly data
To obtain a centered s-point moving average
series X
t
*:

Form the s-point moving averages

Form the centered s-point moving averages
(continued)
+ =
+ +
+ + = =
s/2
1 (s/2) j
j t
*
.5 t
)
2
s
n , 2,
2
s
1,
2
s
,
2
s
(t x x
)
2
s
n , 2,
2
s
1,
2
s
(t
2
x x
x
*
.5 t
*
.5 t
*
t
+ + =
+
=
+

Centered Moving Averages
Used when an even number of values is used in the moving
average
Average periods of 2.5 or 3.5 dont match the original
periods, so we average two consecutive moving averages to
get centered moving averages
Average
Period
4-Quarter
Moving
Average
2.5 28.75
3.5 31.00
4.5 33.00
5.5 35.00
6.5 37.50
7.5 38.75
8.5 39.25
9.5 41.00
Centered
Period
Centered
Moving
Average
3 29.88
4 32.00
5 34.00
6 36.25
7 38.13
8 39.00
9 40.13
etc
Calculating the
Ratio-to-Moving Average
Now estimate the seasonal impact
Divide the actual sales value by the centered
moving average for that period

*
t
t
x
x
100
Calculating a Seasonal Index
Quarter Sales
Centered
Moving
Average
Ratio-to-
Moving
Average
1
2
3
4
5
6
7
8
9
10
11

23
40
25
27
32
48
33
37
37
50
40

29.88
32.00
34.00
36.25
38.13
39.00
40.13
etc

83.7
84.4
94.1
132.4
86.5
94.9
92.2
etc

83.7
29.88
25
(100)
x
x
100
*
3
3
= =
Calculating Seasonal Indexes
Quarter Sales
Centered
Moving
Average
Ratio-to-
Moving
Average
1
2
3
4
5
6
7
8
9
10
11

23
40
25
27
32
48
33
37
37
50
40

29.88
32.00
34.00
36.25
38.13
39.00
40.13
etc

83.7
84.4
94.1
132.4
86.5
94.9
92.2
etc

1. Find the median
of all of the
same-season
values
2. Adjust so that
the average over
all seasons is
100
Fall
Fall
Fall
(continued)
Interpreting Seasonal Indexes
Suppose we get these
seasonal indexes:
Season
Seasonal
Index
Spring 0.825
Summer 1.310
Fall 0.920
Winter 0.945
E = 4.000 -- four seasons, so must sum to 4
Spring sales average 82.5% of the
annual average sales
Summer sales are 31.0% higher
than the annual average sales
etc
Interpretation:
Exponential Smoothing
A weighted moving average
Weights decline exponentially
Most recent observation weighted most

Used for smoothing and short term
forecasting (often one or two periods into
the future)
Exponential Smoothing
The weight (smoothing coefficient) is o
Subjectively chosen
Range from 0 to 1
Smaller o gives more smoothing, larger o
gives less smoothing
The weight is:
Close to 0 for smoothing out unwanted cyclical
and irregular components
Close to 1 for forecasting
(continued)
Exponential Smoothing Model
Exponential smoothing model

where:
= exponentially smoothed value for period t
= exponentially smoothed value already
computed for period i - 1
x
t
= observed value in period t
o = weight (smoothing coefficient), 0 < o < 1
1 1
x x =
n) , 1,2, t 1; (0 )x (1 x x
t 1 t t
= < < + =

t
x
1 - t
x
Exponential Smoothing Example
Suppose we use weight o = .2
Time
Period
(i)
Sales
(Y
i
)
Forecast
from prior
period (E
i-1
)
Exponentially Smoothed
Value for this period (E
i
)
1
2
3
4
5
6
7
8
9
10
etc.
23
40
25
27
32
48
33
37
37
50
etc.
--
23
26.4
26.12
26.296
27.437
31.549
31.840
32.872
33.697
etc.
23
(.2)(40)+(.8)(23)=26.4
(.2)(25)+(.8)(26.4)=26.12
(.2)(27)+(.8)(26.12)=26.296
(.2)(32)+(.8)(26.296)=27.437
(.2)(48)+(.8)(27.437)=31.549
(.2)(48)+(.8)(31.549)=31.840
(.2)(33)+(.8)(31.840)=32.872
(.2)(37)+(.8)(32.872)=33.697
(.2)(50)+(.8)(33.697)=36.958
etc.
= x
1

since no
prior
information
exists
1
x
t 1 t t
0.2)x (1 x 0.2 x + =

Sales vs. Smoothed Sales
Fluctuations
have been
smoothed

NOTE: the
smoothed value in
this case is
generally a little low,
since the trend is
upward sloping and
the weighting factor
is only .2
0
10
20
30
40
50
60
1 2 3 4 5 6 7 8 9 10
Time Period
S
a
l
e
s
Sales Smoothed
Forecasting Time Period (t + 1)
The smoothed value in the current period (t)
is used as the forecast value for next period
(t + 1)

At time n, we obtain the forecasts of future
values, X
n+h
of the series
) 1,2,3 (h x x
n h n
= =
+

Exponential Smoothing in Excel
Use tools / data analysis /
exponential smoothing

The damping factor is (1 - o)
To perform the Holt-Winters method of forecasting:
Obtain estimates of level and trend T
t
as

Where o and | are smoothing constants whose
values are fixed between 0 and 1
Standing at time n , we obtain the forecasts of future
values, X
n+h
of the series by
Forecasting with the Holt-Winters
Method: Nonseasonal Series
t
x
1 2 2 2 1
x x T x x = =
n) , 3,4, t 1; (0 )x (1 ) T x ( x
t 1 t 1 t t
= < < + + =

n n h n
hT x x + =
+

n) , 3,4, t 1; (0 ) x x )( (1 T T
1 t t 1 t t
= < < + =

Assume a seasonal time series of period s
The Holt-Winters method of forecasting uses
a set of recursive estimates from historical
series
These estimates utilize a level factor, o, a
trend factor, |, and a multiplicative seasonal
factor,

Method: Seasonal Series
The recursive estimates are based on the following
equations
1) (0
F
x
) (1 ) T x ( x
s t
t
1 t 1 t t
< < + + =

1) (0
x
x
) (1 F F
t
t
s t t
< < + =

1) (0 ) x x )( (1 T T
1 t t 1 t t
< < + =

Where is the smoothed level of the series, T
t
is the smoothed trend
of the series, and F
t
is the smoothed seasonal adjustment for the series
t
x
(continued)
After the initial procedures generate the level,
trend, and seasonal factors from a historical
series we can use the results to forecast future
values h time periods ahead from the last
observation X
n
in the historical series
The forecast equation is
s h t t t h n
)F hT x ( x
+ +
+ =

where the seasonal factor, F
t
, is the one generated for
the most recent seasonal time period
(continued)
Autoregressive Models
Used for forecasting
Takes advantage of autocorrelation
1st order - correlation between consecutive values
2nd order - correlation between values 2 periods
apart
p
th
order autoregressive model:
Random
Error
t p t p 2 t 2 1 t 1 t
x x x x + + + + + =

Let X
t
(t = 1, 2, . . ., n) be a time series
A model to represent that series is the autoregressive
model of order p:

where
, |
1
|
2
, . . .,|
p
are fixed parameters
c
t
are random variables that have
mean 0
constant variance
and are uncorrelated with one another
t p t p 2 t 2 1 t 1 t
x x x x + + + + + =

(continued)
The parameters of the autoregressive model are
estimated through a least squares algorithm, as the
values of , |
1
|
2
, . . .,|
p
for which the sum of
squares

is a minimum
2
p t p 2 t 2 1 t 1
n
1 p t
t
) x x x (x SS

+ =
=

(continued)
Forecasting from Estimated
Consider time series observations x
1
, x
2
, . . . , x
t

Suppose that an autoregressive model of order p has been fitted to
these data:

Standing at time n, we obtain forecasts of future values of the
series from

Where for j > 0, is the forecast of X
t+j
standing at time n and
for j s 0 , is simply the observed value of X
t+j
t p t p 2 t 2 1 t 1 t
x x x x + + + + + =

) 1,2,3, (h x x x x
p h t p 2 h t 2 1 h t 1 h t
= + + + + =
+ + + +

j n
x
+
j n
x
+
Autoregressive Model:
Example
Year Units
1999 4
2000 3
2001 2
2002 3
2003 2
2004 2
2005 4
2006 6
The Office Concept Corp. has acquired a number of office
units (in thousands of square feet) over the last eight years.
Develop the second order autoregressive model.
Autoregressive Model:
Example Solution
Year x
t
x
t-1
x
t-2

99 4 -- --
00 3 4 --
01 2 3 4
02 3 2 3
03 2 3 2
04 2 2 3
05 4 2 2
06 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
Develop the 2nd order
table
Use Excel to estimate a
regression model
2 t 1 t t
0.9375x 0.8125x 3.5 x

+ =
Autoregressive Model
Example: Forecasting
Use the second-order equation to forecast
number of units for 2007:
4.625
0.9375(4) 0.8125(6) 3.5
) 0.9375(x ) 0.8125(x 3.5 x
0.9375x 0.8125x 3.5 x
2005 2006 2007
2 t 1 t t
=
+ =
+ =
+ =

Autoregressive Modeling Steps
Choose p
Form a series of lagged predictor
variables x
t-1
, x
t-2
, ,x
t-p
Run a regression model using all p
variables
Test model for significance
Use model for forecasting

Chapter Summary
Discussed weighted and unweighted index numbers
Used the runs test to test for randomness in time series
data
Addressed components of the time-series model
Addressed time series forecasting of seasonal data
using a seasonal index
Performed smoothing of data series
Moving averages
Exponential smoothing
Addressed autoregressive models for forecasting

Chap19 Time-Series Analysis and Forecasting

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Chap19 Time-Series Analysis and Forecasting

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Chap 19-1 Statistics for Business and Economics, 6e 2007 Pearson Education, Inc.

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