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1.4 Forecasting Data and Methods

This document discusses forecasting methods and time series data. It explains that the appropriate forecasting method depends on what data is available, and qualitative methods may need to be used if no relevant data exists. Quantitative forecasting requires numerical past data and an assumption that past patterns will continue. Time series data is collected at regular intervals over time and examples are provided. Common time series forecasting methods are described including decomposition models, exponential smoothing models, and ARIMA models. The document also discusses using predictor variables in time series forecasting and different types of models like explanatory, time series, and mixed models.

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Vicente Camarillo Adame
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58 views4 pages

1.4 Forecasting Data and Methods

This document discusses forecasting methods and time series data. It explains that the appropriate forecasting method depends on what data is available, and qualitative methods may need to be used if no relevant data exists. Quantitative forecasting requires numerical past data and an assumption that past patterns will continue. Time series data is collected at regular intervals over time and examples are provided. Common time series forecasting methods are described including decomposition models, exponential smoothing models, and ARIMA models. The document also discusses using predictor variables in time series forecasting and different types of models like explanatory, time series, and mixed models.

Uploaded by

Vicente Camarillo Adame
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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1.

4 Forecasting data and methods

The appropriate forecasting methods depend largely on what data are available.

If there are no data available, or if the data available are not relevant to the
forecasts, then qualitative forecasting methods must be used. These methods
are not purely guesswork—there are well-developed structured approaches to
obtaining good forecasts without using historical data. These methods are
discussed in Chapter 4.

Quantitative forecasting can be applied when two conditions are satisfied:

1. numerical information about the past is available;


2. it is reasonable to assume that some aspects of the past patterns will continue
into the future.

There is a wide range of quantitative forecasting methods, often developed within


specific disciplines for specific purposes. Each method has its own properties,
accuracies, and costs that must be considered when choosing a specific method.

Most quantitative prediction problems use either time series data (collected at
regular intervals over time) or cross-sectional data (collected at a single point in
time). In this book we are concerned with forecasting future data, and we
concentrate on the time series domain.

Time series forecasting

Examples of time series data include:

Daily IBM stock prices


Monthly rainfall
Quarterly sales results for Amazon
Annual Google profits
Anything that is observed sequentially over time is a time series. In this book, we
will only consider time series that are observed at regular intervals of time (e.g.,
hourly, daily, weekly, monthly, quarterly, annually). Irregularly spaced time
series can also occur, but are beyond the scope of this book.

When forecasting time series data, the aim is to estimate how the sequence of
observations will continue into the future. Figure 1.1 shows the quarterly
Australian beer production from 1992 to the second quarter of 2010.

Figure 1.1: Australian quarterly beer production: 1992Q1–2010Q2, with two years of
forecasts.

The blue lines show forecasts for the next two years. Notice how the forecasts
have captured the seasonal pattern seen in the historical data and replicated it for
the next two years. The dark shaded region shows 80% prediction intervals. That
is, each future value is expected to lie in the dark shaded region with a probability
of 80%. The light shaded region shows 95% prediction intervals. These prediction
intervals are a useful way of displaying the uncertainty in forecasts. In this case
the forecasts are expected to be accurate, and hence the prediction intervals are
quite narrow.
The simplest time series forecasting methods use only information on the
variable to be forecast, and make no attempt to discover the factors that a!ect its
behaviour. Therefore they will extrapolate trend and seasonal patterns, but they
ignore all other information such as marketing initiatives, competitor activity,
changes in economic conditions, and so on.

Time series models used for forecasting include decomposition models,


exponential smoothing models and ARIMA models. These models are discussed in
Chapters 6, 7 and 8, respectively.

Predictor variables and time series forecasting

Predictor variables are often useful in time series forecasting. For example,
suppose we wish to forecast the hourly electricity demand (ED) of a hot region
during the summer period. A model with predictor variables might be of the form

ED=f(current temperature, strength of economy, population,


time of day, day of week, error).

The relationship is not exact — there will always be changes in electricity demand
that cannot be accounted for by the predictor variables. The “error” term on the
right allows for random variation and the e!ects of relevant variables that are not
included in the model. We call this an explanatory model because it helps
explain what causes the variation in electricity demand.

Because the electricity demand data form a time series, we could also use a time
series model for forecasting. In this case, a suitable time series forecasting
equation is of the form

EDt+1 = f(EDt , EDt−1 , EDt−2 , EDt−3 , … , error),

where t is the present hour, t + 1 is the next hour, t − 1 is the previous hour,
t − 2 is two hours ago, and so on. Here, prediction of the future is based on past
values of a variable, but not on external variables which may a!ect the system.
Again, the “error” term on the right allows for random variation and the e!ects
of relevant variables that are not included in the model.

There is also a third type of model which combines the features of the above two
models. For example, it might be given by
EDt+1 = f(EDt , current temperature, time of day, day of week, error).

These types of “mixed models” have been given various names in di!erent
disciplines. They are known as dynamic regression models, panel data models,
longitudinal models, transfer function models, and linear system models
(assuming that f is linear). These models are discussed in Chapter 9.

An explanatory model is useful because it incorporates information about other


variables, rather than only historical values of the variable to be forecast.
However, there are several reasons a forecaster might select a time series model
rather than an explanatory or mixed model. First, the system may not be
understood, and even if it was understood it may be extremely di"cult to
measure the relationships that are assumed to govern its behaviour. Second, it is
necessary to know or forecast the future values of the various predictors in order
to be able to forecast the variable of interest, and this may be too di"cult. Third,
the main concern may be only to predict what will happen, not to know why it
happens. Finally, the time series model may give more accurate forecasts than an
explanatory or mixed model.

The model to be used in forecasting depends on the resources and data available,
the accuracy of the competing models, and the way in which the forecasting
model is to be used.

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