FORECASTING

MODEL
RAJ GAUR
214213003

Introduction to Forecasting
What is forecasting?
Primary Function is to Predict the Future using
(time series related or other) data we have in
hand

Why are we interested?

Affects the decisions we make today

Where is forecasting used

forecast demand for products and services
forecast availability/need for manpower
forecast inventory and materiel needs daily

What Makes a Good

Forecast?
It should be timely
It should be as accurate as possible
It should be reliable
It should be in meaningful units
It should be presented in writing
The method should be easy to use and understand in
most cases.

Types of Forecasting
Methods
Forecasting methods are classified into two groups:

Types of Forecasting
Models
Qualitative methods judgmental
methods
Forecasts generated subjectively by the forecaster
Educated guesses

Quantitative methods based on

mathematical modeling
Forecasts generated through mathematical modeling

Qualitative Methods

Quantitative Methods
Time Series Models:
Assumes information needed to generate a
forecast is contained in a time series of data
Assumes the future will follow same patterns
as the past

Causal Models or Associative Models

Explores cause-and-effect relationships
Uses leading indicators to predict the future
Housing starts and appliance sales

Time Series Models

Forecaster looks for data patterns as
Data = historic pattern + random variation

Historic pattern to be forecasted:

Level (long-term average) data fluctuates around a constant
mean
Trend data exhibits an increasing or decreasing pattern
Seasonality any pattern that regularly repeats itself and is
of a constant length
Cycle patterns created by economic fluctuations

Random Variation cannot be predicted

Time Series Patterns

Moving Averages
In words: the arithmetic average of the n most recent
observations. For a one-step-ahead forecast:
Ft = (1/N) (Dt - 1 + Dt - 2 + . . . + Dt - n )

example
MONTH

Demand

Month

Demand

January

89

July

223

February

57

August

286

March

144

September

212

April

221

October

275

May

177

November

188

June

280

December

312

3 month MA: (oct+nov+dec)/3=258.33

6 month MA: (jul+aug+
+dec)/6=249.33
12 month MA: (Jan+feb+
+dec)/12=205.33

Summary of Moving Averages

Advantages of Moving Average Method
Easily understood
Easily computed
Provides stable forecasts

Disadvantages of Moving Average

Method
Requires saving lots of past data points: at
least the N periods used in the moving
average computation
Lags behind a trend
Ignores complex relationships in data

Weighted Moving
Average
consists of computing a weighted
average of the most recent n data values
for the series and using this weighted
average for forecasting the value of the
time series for the next period.
The more recent observations are
typically given more weight than older
observations.
For convenience, the weights usually
sum to 1.

Weighted Moving
Average
All weights must add to 100% or 1.00
e.g. Ct .5, Ct-1 .3, Ct-2 .2 (weights add
to 1.0)

Ft 1 C t A t

Exponential Smoothing
The forecast for the next period is equal to the forecast
for the current period plus a proportion () of the
forecast error in the current period.
Using exponential smoothing, the forecast is calculated
by:

Ft+1=Yt + (1- )Ft

where:
is the smoothing constant (a number between 0 and 1)
Ft is the forecast for period t
Ft +1 is the forecast for period t+1
Yt is the actual data value for period t

Exponential Smoothing

F11 = 0.1 * Y10 + .9 F10

= .1 *130 + .9 * 115.4099
= 116.87

Effect of value on the

Forecast
Small values of means that the
forecasted value will be stable
(show low variability

Low increases the lag of the

forecast to the actual data if a trend is
present

Large values of mean that the

forecast will more closely track the
actual time series

Forecasting Trend

Basic forecasting models for trends compensate for the

lagging that would otherwise occur
One model, trend-adjusted exponential smoothing
uses a three step process
Step 1 - Smoothing the level of the series

S t A t (1 )(S t 1 Tt 1 )
Step 2 Smoothing the trend

Tt (S t S t 1 ) (1 )Tt 1
Forecast including the trend

Causal
Models
Often, leading indicators can help to predict

changes in future demand e.g. housing starts

Causal models establish a cause-and-effect
relationship between independent and
dependent variables
A common tool of causal modeling is linear
regression: Y a bx
Additional related variables may require
multiple regression modeling

Linear Regression

XY X Y
X 2 X X

Identify dependent (y)

and independent (x)
variables
Solve for the slope of the
XY n X Y
line
b

nX

Solve for the y intercept

Develop your equation

for the trend line

a Y bX

Y=a + bX

Measuring Forecasting
Accuracy

Mean Absolute Deviation

(MAD)

actual forecast

MAD
n

measures the total error in a

forecast without regard to sign

Cumulative Forecast Error

(CFE)
Measures any bias in the
forecast

Mean Square Error (MSE)

Penalizes larger errors

CFE actual forecast

actual - forecast

MSE
n