Statistics for Business

and Economics
Anderson Sweeney
Williams
Slides by
John Loucks
St. Edward’s University

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 Chapter 18, Part B
Forecasting
 Trend Projection
 Seasonality and Trend
 Time Series Decomposition

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 Trend Projection

 If a time series exhibits a linear trend, the

method of least squares may be used to
determine a trend line (projection) for future
 forecasts.
Least squares, also used in regression analysis,
determines the unique trend line forecast which
minimizes the mean square error between the
trend line forecasts and the actual observed
values for the time series.
 The independent variable is the time period and
the dependent variable is the actual observed
value in the time series.

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 Linear Trend Regression

 Using the method of least squares, the formula for

the trend projection is:

Tt = b0 + b1t

where: Tt = linear trend forecast in

period t
b0 = intercept of the linear
trend line
b1 = slope of the linear trend
line
t = time period
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 Linear Trend Regression

 For the trend projection equation Tt = b0 + b1t

n

 (t  t )(Y t  Y)
b1  t 1 n b0 Y  b1t
 (t
t 1
 t )2

where: Yt = value of the time series in period t

n = number of time periods
Y
(observations)
= average values of the time series
t= average value of t

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 Linear Trend Regression

 Example: Auger’s Plumbing

Service
The number of plumbing repair jobs
performed by
Auger's Plumbing Service in the last nine months
is Month Jobs Month Jobs
Forecast the number
oflisted on the right. March 353 August 409
repair jobs Auger's April 387 September 399
will May 342 October 412
perform in December June 374 November 408
using the least July 396
squares
method.
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 Linear Trend Regression

2
(month) t t  t (t  t ) Y(tYt  Y ) (t  t )(Yt  Y )
(Mar.) 1 -4 16 353 -33.67 134.68
(Apr.) 2 -3 9 387 0.33 -0.99
(May) 3 -2 4 342 -44.67 89.34
(June) 4 -1 1 374 -12.67 12.67
(July) 5 0 0 396 9.33 0
(Aug.) 6 1 1 409 22.33 22.33
(Sep.) 7 2 4 399 12.33 24.66
(Oct.) 8 3 9 412 25.33 75.99
(Nov.) 9 4 16 408 21.33 85.32
Sum 45 60 3480 444.00
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 Linear Trend Regression

t 45/ 9 5 Y 3480/ 9 386.667

n

 (t  t )(Y t  Y)
3480
b1  t 1 n
 7.12
60
 (t
t 1
 t )2

b0 Y  b1t 386.667  7.12(5) 351.07

T10 = 351.07 + (7.12)(10) =

422.27

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 Trend Projection

 Example: Auger’s Plumbing

Service
Forecast for December (Month 10) using
a
three-period (k = 3) weighted moving average
with Month Jobs Month Jobs
weights of .6, .3, and .1 March 353 August 409
for the newest to oldest April 387 Septem. 399
data, respectively. Then,May 342 October 412
compare this Month 10 June 374 Novem. 408
weighted moving averageJuly 396
forecast with the Month 10
trend projection forecast.
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 Trend Projection

 Three-Month Weighted Moving Average

The forecast for December will be the weighted
average of the preceding three months: September,
October, and November.
F10 = .1YSep. + .3YOct. + .6YNov.
= .1(399) + .3(412) + .6(408)
= 408.3
 Trend Projection
F10 = 422.27 (from earlier slide)

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 Trend Projection

 Conclusion
Due to the positive trend component in
the time series, the trend projection produced a
forecast that is more in line with the trend that
exists. The weighted moving average, even
with heavy (.6) weight placed on the current
period, produced a forecast that is lagging
behind the changing data.

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 Holt’s Linear Exponential Smoothing

 Charles Holt developed a version of

exponential smoothing that can be used to
forecast a time series with a linear trend.
 Forecasts for Holt’s method are obtained using
two smoothing constants, a and b, and three
equations.
 Holt’s linear exponential smoothing is often
called double exponential smoothing.

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 Holt’s Linear Exponential Smoothing

 Equations for Holt’s Linear Exponential Smoothing

Lt = aYt + (1 – a)(Lt-1 + bt-1)

bt = b(Lt – Lt-1) + (1 – b)bt-1
Ft+k = Lt +btk

where: Lt = estimate of the level of time series in

period t
bt = estimate of the slope of time series
in period t
a = smoothing constant for level
b = smoothing constant for slope
Ft+k = forecast
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k = number of periods ahead to be
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 Holt’s Linear Exponential Smoothing

 To get the method started we need values for

L1, the estimate of the level in period 1, and
b1, the estimate of the slope in period 1.
 A commonly used approach is to set L1 = Y1
and b1 = Y2 – Y1.

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 Holt’s Linear Exponential Smoothing

 Example: Auger’s Plumbing

Service
Forecast the number of plumbing jobs
Auger’s
will have in months April through December
using Month Jobs Month Jobs
Holt’s exponential March 353 August 409
smoothing method,April 387 September 399
with a = .1 and May 342October 412
b = .2. June 374 November 408
July 396

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 Holt’s Linear Exponential Smoothing

 Using Smoothing Constant Values  = .1, b = .2

L1 = Y1 = 353
b1 = Y2 - Y1 = 387 - 353 = 34
F2 = L1 + b1(1) = 353 + 34 = 387
L2 = .1(Y2) + .9(L1 + b1) = .1(387) + .9(353
+b234) = 387
= .2(L 2 - L1) + .8(b1) = .2(387 - 353)

F+3 =
.8(34)
L2 + =b234
(1) = 387 + 34 = 421

L3 = .1(Y3) + .9(L2 + b2) = .1(342) + .9(387 +

34)
b3 ==.2(L
413.1
3 – L2) + .8(b2) = .2(413.1 - 387)

F+4 =
.8(34)
L3 + = b332.42
(1) = 413.1 + 32.42 =
445.52
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 Holt’s Linear Exponential Smoothing

 Using Smoothing Constant Values  = .1, b = .2

L4 = .1(Y4) + .9(L3 + b3) = .1(374) + .9(413.1 +
32.42) = 4438.37
b4 = .2(L – L3) + .8(b3) = .2(438.37 – 413.1)
F+5 =
.8(32.42) = 30.99
L4 + b4(1) = 438.37 + 30.99 =
469.36
L = .1(Y ) + .9(L + b ) = .1(396) + .9(438.37 +
5 5 4 4
30.99) =5462.02
b5 = .2(L – L4) + .8(b4) = .2(462.02 – 438.37)
F+6 =
.8(30.99) = 29.52
L5 + b5(1) = 462.02 + 29.52 =
491.54
L6 = .1(Y6) + .9(L5 + b5) = .1(409) + .9(462.02 +
29.52) =6483.29
b6 = .2(L – L5) + .8(b5) = .2(483.29 – 462.02)
F+ =.8(29.52)
7L + b (1)
6
= 27.87
= 483.29 + 27.87 =
6
511.16
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 Holt’s Linear Exponential Smoothing

 Using Smoothing Constant Values  = .1, b = .2

L7 = .1(Y7) + .9(L6 + b5) = .1(399) + .9(483.29 +
29.52) = 7499.95
b7 = .2(L – L6) + .8(b6) = .2(499.95 – 483.29)
F+8 =
.8(27.87) = 25.63
L7 + b7(1) = 499.95 + 25.63 =
525.57
L8 = .1(Y8) + .9(L7 + b6) = .1(412) + .9(499.95 +
27.87) =8514.22
b8 = .2(L – L7) + .8(b7) = .2(514.22 – 499.95)
F+9 =
.8(25.63) = 23.36
L8 + b8(1) = 514.22 + 23.36 =
537.57
L9 = .1(Y9) + .9(L8 + b7) = .1(408) + .9(514.22 +
25.63) =9524.62
b9 = .2(L – L8) + .8(b8) = .2(524.62 – 514.22)
F+10.8(23.36) = 20.77
= L9 + b9(1) = 524.62 + 20.77 =
545.38
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 Nonlinear Trend Regression

 Sometimes time series have a curvilinear or

nonlinear trend.
 A variety of nonlinear functions can be used to
develop an estimate of the trend in a time
series.
 One example is this quadratic trend equation:
Tt = b0 + b1t + b2t2
 Another example is this exponential trend
equation:
Tt = b0(b1)t

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 Seasonality without Trend

 To the extent that seasonality exists, we need

to incorporate it into our forecasting models to
ensure accurate forecasts.
 We will first look at the case of a seasonal
time series with no trend and then discuss
how to model seasonality with trend.

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 Seasonality without Trend

 Example: Umbrella Sales

Year Quarter Quarter Quarter Quarter
1 2 3 4
1 125 153 106 88
2 118 161 133 102
3 138 144 113 80
4 109 137 125 109
5 130 165 128 96
 Sometimes it is difficult to identify patterns in
a time series presented in a table.
 Plotting the time series can be very
informative.

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 Seasonality without Trend

 Umbrella Sales Time Series Plot

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 Seasonality without Trend

 The time series plot does not indicate any long-

term trend in sales.
 However, close inspection of the plot does
reveal a seasonal pattern.
 The first and third quarters have moderate
sales,
 the second quarter the highest sales, and
 the fourth quarter tends to be the lowest
quarter in terms of sales.

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 Seasonality without Trend

 Recall from an earlier chapter that dummy

variables can be used to deal with categorical
independent variables in a multiple regression
model.
 We will treat the season as a categorical
variable.
 Recall that when a categorical variable has k
levels, k – 1 dummy variables are required.
 If there are four seasons, we need three
dummy variables.
 Qtr1 = 1 if Quarter 1, 0 otherwise
 Qtr2 = 1 if Quarter 2, 0 otherwise
 Qtr3 = 1 if Quarter 3, 0 otherwise

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 Seasonality without Trend

 General Form of Estimated Regression Equation

is:
Yˆ b  b (Qtr 1)  b (Qtr 2)  b (Qtr 3)
0 1 2 3

 Estimated Regression Equation is:

Sales 95.0  29.0(Qtr 1)  57.0(Qtr 2)  26.0(Qtr 3)
 The forecasts of quarterly sales in year 6 are:
 Quarter 1: Sales = 95 + 29(1) + 57(0) +
26(0) = 124
 Quarter 2: Sales = 95 + 29(0) + 57(1) +
26(0) = 152
 Quarter 3: Sales = 95 + 29(0) + 57(0) +
26(1) = 121
 Quarter 4: Sales = 95 + 29(0) + 57(0) +
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26(0)
or duplicated, = to a95
or posted publicly accessible website, in whole or in part.
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 Seasonality and Trend

 We will now extend the regression approach to

include situations where the time series
contains both a seasonal effect and a linear
trend.
 We will introduce an additional independent
variable to represent time.

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 Seasonality and Trend

 Example: Terry’s Tie

Shop Business at Terry's Tie Shop can be
viewed as
falling into three distinct seasons: (1)
Christmas
(November and December); (2) Father's Day
Average weekly sales ($) during each of
(late
the
May to mid June); and (3) all other times.
three seasons during the past four years are
shown on the next slide.

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 Seasonality and Trend

 Example: Terry’s Tie Shop

Season
Year 1 2 3
1 1856 2012 985
2 1995 2168 1072
3 2241 2306 1105
4 2280 2408 1120

Determine a forecast for the average weekly

sales in year 5 for each of the three seasons.

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 Seasonality and Trend

 There are three seasons, so we will need two

dummy variables.
 Seas1 = 1 if Season 1, 0 otherwise
 Seas2 = 1 if Season 2, 0 otherwise

 General Form of Estimated Regression Equation

is:
Yˆ b  b (Seas1)  b (Seas2)  b (t)
0 1 2 3

 Estimated Regression Equation is:

Sales 797.0  1095.43(Seas1)  1189.47(Seas2)  36.47(t)

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 Seasonality and Trend

 The forecasts of average weekly sales in the

three seasons of year 5 are:
Seas. 1: Sales = 797 + 1095.43(1) + 1189.47(0) +
36.47(13)
Seas. 2: Sales== 2366.5
797 + 1095.43(0) + 1189.47(1) +
36.47(14)
Seas. 3: Sales== 2497.0
797 + 1095.43(0) + 1189.47(0) +
36.47(15)
= 1344.0

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 Time Series Decomposition

 Time series decomposition can be used to

separate or decompose a time series into
seasonal, trend, and irregular (error)
components.
 While this method can be used for forecasting,
its primary applicability is to get a better
understanding of the time series.
 Understanding what is really going on with a
time series often depends upon the use of
deseasonalized data.

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 Time Series Decomposition

 Decomposition methods assume that the

actual time series value at period t is a
function of three components: trend,
seasonal, and irregular.
 How these three components are combined to
give the observed values of the time series
depends upon whether we assume the
relationship is best described by an additive
or a multiplicative model.

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 Time Series Decomposition
 Additive Model
 An additive model follows the form:
Yt = Trendt + Seasonalt + Irregulart
where:
Trendt = trend value at time period t
Seasonalt = seasonal value at time period t
Irregulart = irregular value at time period t
 An additive model is appropriate in situations
where the seasonal fluctuations do not
depend upon the level of the time series.

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 Time Series Decomposition
 Multiplicative Model
 A multiplicative model follows the form:
Yt = Trendt x Seasonalt x Irregulart
where:
Trendt = trend value at time period t
Seasonalt = seasonal value at time period t
Irregulart = irregular value at time period t
 A multiplicative model is appropriate, for
example, if the seasonal fluctuations grow
larger as the sales volume increases because
of a long-term linear trend.

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 Time Series Decomposition

 Example: Terry’s Tie Shop

Season
Year 1 2 3
1 1856 2012 985
2 1995 2168 1072
3 2241 2306 1105
4 2280 2408 1120

Determine a forecast for the average weekly

sales in year 5 for each of the three seasons.

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 Calculating the Seasonal Indexes

Step 1. Calculate the centered moving

averages.
There are three distinct seasons in each
year. Hence, take a three-season moving
average to eliminate seasonal and irregular
factors. For example:

1st CMA = (1856 + 2012 + 985)/3 = 1617.67

2nd CMA = (2012 + 985 + 1995)/3 = 1664.00
Etc.

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 Calculating the Seasonal Indexes

Step 2. Center the CMAs on integer-valued

periods.The first centered moving average
computed in step 1 (1617.67) will be
centered on season 2 of year 1. Note that
the moving averages from step 1 center
themselves on integer-valued periods
because n is an odd number.

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 Calculating the Seasonal Indexes

Dollar Moving
Year Season Sales (Yt) Average
(1856 + 2012 +
1 1 185 985)/3
2 6 1617.67
3 201 1664.00
2 1 2
199 1716.00
2 5 1745.00
3 985
216 1827.00
3 1 8
224 1873.00
2 107
1 1884.00
3 2
230 1897.00
4 1 228
6 1931.00
2 0
110 1936.00
3 240
5
8
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112 accessible website, in whole or in part. Slide
38
or duplicated, or posted to a publicly
 Calculating the Seasonal Indexes

 The centered moving average values tend to

“smooth
out” both the seasonal and irregular
fluctuations in
 The
the centered moving averages represent the
time series.
trend in
the data and any random variation that was
not
removed by using the moving averages to
smooth
the data.

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 Calculating the Seasonal Indexes

Step 3. Determine the seasonal & irregular factors

(St It ). By dividing each actual by the moving
average for the same time period, we
identify the combined seasonal-irregular
effect in the time series.

St It = Yt /(Moving Average for period t )

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 Calculating the Seasonal Indexes

Dollar Moving
Year Season Sales (Yt) Average StIt
2012/1617.
1 1 185 67
2 6 1617.67 1.244
3 201 1664.00 .592
2 1 2 1716.00 1.163
2 1745.00 1.242
3 985 1827.00 .587
3 1 199 1873.00 1.196
2 5 1884.00 1.224
3 216 1897.00 .582
4 1 8 1931.00 1.181
2 107 1936.00 1.244
3 2
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1
 Calculating the Seasonal Indexes

Step 4. Determine the average seasonal factors.

Averaging all St It values corresponding to
that season:

Season 1: (1.163 + 1.196 + 1.181) /3 = 1.180

Season 2: (1.244 + 1.242 + 1.224 + 1.244) /4 = 1.238
Season 3: (.592 + .587 + .582) /3 = .587

3.005

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 Calculating the Seasonal Indexes

Step 5. Scale the seasonal factors (St ).

Average the seasonal factors = (1.180 +
1.238 + .587)/3 = 1.002. Then, divide each
seasonal factor by the average of the
seasonal factors.
Season 1: 1.180/1.002 = 1.178
Season 2: 1.238/1.002 = 1.236
Season 3: .587/1.002 = .586

3.000

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 Calculating the Seasonal Indexes

Dollar Moving Scaled

Year Season Sales (Yt) Average StIt St
1 1 185 1.178
2 6 1617.67 1.244 1.236
3 201 1664.00 .592 .586
2 1 2 1716.00 1.163 1.178
2 1745.00 1.242 1.236
3 985 1827.00 .587 .586
3 1 199 1873.00 1.196 1.178
2 5 1884.00 1.224 1.236
3 216 1897.00 .582 .586
4 1 8 1931.00 1.181 1.178
2 107 1936.00 1.244 1.236
3 2 .586
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1
 Using the Deseasonalizing Time Series
to Identify Trend
Step 6. Determine the deseasonalized data.
Divide the data point values, Yt , by St .

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 Using the Deseasonalizing Time Series
to Identify Trend
1856/1.17
Dollar Moving8 Scaled
Year Season Sales (Yt) Average StIt St Yt/St
1 1 185 1.178 1576
2 6 1617.67 1.244 1.236 1628
3 201 1664.00 .592 .586 1681
2 1 2 1716.00 1.163 1.178 1694
2 1745.00 1.242 1.236 1754
3 985 1827.00 .587 .586 1829
3 1 199 1873.00 1.196 1.178 1902
2 5 1884.00 1.224 1.236 1866
3 216 1897.00 .582 .586 1886
4 1 8 1931.00 1.181 1.178 1935
2 107 1936.00 1.244 1.236 1948
3 2 .586 1911
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or duplicated, or posted to a publicly accessible website, in whole or in part.
1
 Using the Deseasonalizing Time Series
to Identify Trend
Step 7. Determine a trend line of the
deseasonalized
Using thedata.
least squares method for t = 1, 2, ...,
12,
gives:
Tt = b0 + b1t

Deseasonalized Salest = 1580.11 + 33.96t

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied
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47
or duplicated, or posted to a publicly accessible website, in whole or in part.
 Using the Deseasonalizing Time Series
to Identify Trend
Step 8. Determine the deseasonalized
predictions.
Substitute t = 13, 14, and 15 into the
least
squares equation:
T13 = 1580.11 + (33.96)(13) = 2022
T14 = 1580.11 + (33.96)(14)
T15 =
= 1580.11
2056 + (33.96)(15) = 2090

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48
or duplicated, or posted to a publicly accessible website, in whole or in part.
 Seasonal Adjustments

Step 9. Take into account the

seasonality.
Multiply each deseasonalized prediction
by its seasonal factor to give the following
forecasts for year 5:

Season 1: (1.178)(2022) = 2382

Season 2: (1.236)(2056) = 2541
Season 3: ( .586)(2090) = 1225

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied
Slide
49
or duplicated, or posted to a publicly accessible website, in whole or in part.
 End of Chapter 18, Part B

© 2011 Cengage Learning. All Rights Reserved. May not be scanned, copied
Slide
50
or duplicated, or posted to a publicly accessible website, in whole or in part.