Forecast Range

Very long range forecasts do not work well!!

• Forecasts are done under the assumption that the market and other conditions in future are very
much like the present
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• Not that there
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• But the change is gradual, not a drastic change
• A financial crash like 2008 US market will send all forecasts into a tizzy
• Events like Demonetization would throw the forecasts into disarray

Based on the amount of data availability, one should not try to forecast more than a few periods
ahead

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 Scope of Module

• Only univariate TS is explored

• No attempt made to forecast
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more than one interdependent
TS
• The variable measured in TS is
assumed to be continuous and
have fairly decent volume
• Intermittent demand TS is not
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 Gathering Information
Historical data required for future prediction

If volume of data is limited, forecasts will not

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be reliable enough
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If data is available for very long past, data may

not be useful at all

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 Example: Clay Brick Production

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 Example: Clay Brick Production

Series not stable

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Use stable part for forecast

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 Forecast Range
Different industry needs forecast for different range for different purpose
with different accuracy

Example: Airlines industry: Interested in passenger volume forecast

• Long-term forecast: 5-10 years
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• Mid-term forecast: 2-5 years

̶ Manpower hiring / Route alteration

• Short-term forecast: 2 weeks – 6 months

̶ Pilot / Cabin Crew rostering
̶ Dynamic pricing

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Forecast

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 Simple Forecast
 Naïve Forecast: Use the last observed value
 Average Forecast:
 Moving Average Forecast:
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• Move the window

None of these work well even for the most regular

series

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 Moving Average
• One of the most popular and often-
used technical indicators to understand stock
movement
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• The moving average is easy to calculate and,

once plotted on a chart, is a powerful visual
trend-spotting tool.

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 Long Term Movement

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 EXPONENTIAL SMOOTHING
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FORECAST

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 Model Validation
Predictive power of a model is estimated by comparing its
forecasting performance on a Test Data

A part of sample data is used to train (develop) the model:

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LZSQFTU6A9 Training Data
A part of sample is withheld from estimation process: Test
Data

The model which gives smallest measure of error between

forecast and actual series is the ‘best’

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 Model Validation
• Training Data is used to identify a few working models
• The forecasts for training data are called fitted values
• Each of the models is tested against the observed values of the series
for hold-out period
• The model is selected to be the best where observed and forecasted
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values are the closest

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 Model Validation
• For other predicting models hold-out sample is randomly
chosen from the total sample
• Usually in 80:20 ratio

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• For time series hold-out sample has to be the most recent
LZSQFTU6A9 period because of the ordered nature of the data

Training Data Test Data

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 Model Validation
• If there is seasonality in the data, the at least one
full season’s data need to be held out for validation
• Once a model is selected, held-out period must be
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future

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 Measures of Forecast
Accuracy
• Performance of forecast method is tested by comparing the
forecast values with the test sample observations

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෣ Forecast Values
𝑌(𝑡)
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Y(t)Observed Values
Compare the observed and forecast values through
various methods

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 Measures of Forecast Accuracy
 Residual sum of squares
෣
RSS = σ 𝑌 𝑡 − 𝑌(𝑡) 2

 Mean sum of squares

1
෣
MSS = σ 𝑌 𝑡 − 𝑌(𝑡) 2
𝑇
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 Mean absolute deviation
1 ෣
MAD =𝑇 σ |𝑌 𝑡 − 𝑌 𝑡 |

 Mean absolute percent error

1
MAPE = 𝑇 σ[ |𝑌 𝑡 − 𝑌෣
𝑡 | / 𝑌 𝑡 ] x 100

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 Forecast by Average

• Using mean of all past observations – easiest,

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intuitive, naïve
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• Naturally does not work well!!
• Can this scheme be modified to get useful
forecasts?

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 Exponential Smoothing
• Weighted averages of past observations
• Weights decaying as observations get older
• Practically speaking, only the recent observations
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• One or more parameters control how fast the
weights decay
• These parameters have values between 0 and 1

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 Exponential Smoothing

Decreasing weight given 0  1

to older observations

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 (1   )
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 (1   ) 2
 (1   ) 3

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 Simple Exponential (SES)
If the time series neither has a pronounced trend nor
seasonality: Almost non-available!

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 Petrol Consumption

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 Exponential Smoothing
• Performance of the smoothing parameter α controls
performance of the method
• If α is closer to 1, forecasts follow the actual observations
more closely
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LZSQFTU6A9 • If α is closer to 0, forecasts are farther from the actual
observations and the line is smooth

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 Double Exponential

• Applicable when data has Trend but no seasonality

• An extension of SES
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• Level is the local mean
• One smoothing parameter α corresponds to the level series
• A second smoothing parameter β corresponds to the trend
series
• Also known as Holt model

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 Caselet V: US GDP

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Trend Series

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 Caselet V: US GDP

α=0.99
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α=0.99 β=0.05
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MAPE=5% MAPE=4.5%

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 Petrol Consumption

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 Petrol Consumption

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 Exponential Smoothing
with Seasonality: Holt-
Winters’ Model
• Because Seasonality can be additive or multiplicative, HW
model can be additive or multiplicative
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• Simultaneously smooths the level, trend and seasonality

• Three separate smoothing parameters

• α: Smooths level; 0<α<1

• β: Smooths trend; 0<β<1
• γ : Smooths seasonality; 0<γ<1

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 Champagne Sales
Model Estimates

Smoothing parameters:
alpha = 0.0842
beta = 1e-04
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gamma = 0.7608
• Smoothing parameter for trend (β) almost 0 corroborates well with insignificant
YOY movement
• Smoothing parameter for seasonality(γ) fairly high that almost all fluctuations
are due to seasonality

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 Champagne Sales

High sales volume forecasts

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Volume months

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 Champagne Sales

High sales volume forecasts

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months

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 Passenger Volume

Significant trend
and
seasonality both
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 Passenger Volume
Model Estimates

Smoothing parameters:
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alpha = 0.3515
beta = 0.0147
gamma = 0.6481
• Smoothing parameter for trend (β) small compared to
other parameters
• Indicates almost a straight line trend
• Smoothing parameter for seasonality(γ) fairly high
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 Passenger Volume

Forecast values show

small bias MAPE=7%

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[email protected]
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HAPPY LEARNING

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