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Forecasting - 3 - Exponential Smoothing Method

The document discusses various quantitative forecasting methods including naive approach, moving averages, exponential smoothing, trend projection, and linear regression. It focuses on exponential smoothing, describing it as a weighted moving average where weights decline exponentially and most recent data is weighted most. Parameters like the smoothing constant alpha, which ranges from 0 to 1, and beta for trend adjustment are explained along with their impact on forecasts and selecting optimal values.

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Umar Ismail
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122 views18 pages

Forecasting - 3 - Exponential Smoothing Method

The document discusses various quantitative forecasting methods including naive approach, moving averages, exponential smoothing, trend projection, and linear regression. It focuses on exponential smoothing, describing it as a weighted moving average where weights decline exponentially and most recent data is weighted most. Parameters like the smoothing constant alpha, which ranges from 0 to 1, and beta for trend adjustment are explained along with their impact on forecasts and selecting optimal values.

Uploaded by

Umar Ismail
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Quantitative Forecasting Methods

• Naïve Approach
• Moving Averages
• Exponential Smoothing
• Trend projection
• Linear Regression
Exponential Smoothing Method

• Form of weighted moving average


– Weights decline exponentially
– Most recent data weighted most
• Requires smoothing constant ()
– Ranges from 0 to 1
– Subjectively chosen
• Involves little record keeping of past
data
Exponential Smoothing
New forecast =
previous forecast + (previous actual -
previous)
Ft = Ft-1 + (At-1 - Ft-1)
or:
Ft = new forecast
where
Ft-1 = previous forecast
 = smoothing constant
At-1 = previous period actual
Exponential Smoothing
Equations
• Ft = At - 1 + (1-)At - 2 + (1- )2·At - 3
+ (1- )3At - 4 + ... + (1- )t-1·A0
– Ft = Forecast value
– At = Actual value
  = Smoothing constant
Forecast Effects of
Smoothing Constant 
Ft =  At - 1 + (1- ) At - 2 + (1- )2At - 3 + ...
Weights
= Prior Period 2 periods ago 3 periods ago
 (1 - ) (1 - )2

= 0.10
10% 9% 8.1%
= 0.90
90% 9% 0.9%
Table 5.4
Exponential Smoothing with Trend Adjustment

• Simple exponential smoothing - first-


order smoothing
• Trend adjusted smoothing - second-
order smoothing

• Low  gives less weight to more


recent trends, while high  gives
higher weight to more recent trends
Selecting the Smoothing Constant ()

Select  to minimize:
Σ | forecast errors |
Mean Absolute Deviation = MAD 
n

Σ(forecast errors) 2
Mean Square Error = MSE 
n

Mean Absolute Percent Error = MAPE


1  forecast error 
 Σ 
n  actual 

Bias = forecast errors


Error Analysis (Alpha=0.1)
Error Analysis (Alpha=0.5)
Exponential Smoothing with Trend Adjustment

• Simple exponential smoothing - first-


order smoothing
• Trend adjusted smoothing - second-
order smoothing

• Low  gives less weight to more


recent trends, while high  gives
higher weight to more recent trends
Exponential Smoothing with
Trend Adjustment
Forecast including trend (FITt+1) =
new forecast (Ft) + trend
correction(Tt)
Tt = (1 - )Tt-1 + (Ft – Ft-1)
where
Tt = smoothed trend for period t
Tt-1 = smoothed trend for the preceding period
 = trend smoothing constant
Ft = simple exponential smoothed forecast for period t
Ft-1 = forecast for period t-1
Exponential Forecast with TREND
(Alpha=0.1, Beta=0.5)
Trend Projection

General regression equation :

Ŷ  a  bX
where
Ŷ  computed value
of the variable to
be predicted
(dependent variable)
a  Y - axis intercept
XY - nXY
b
X 2  nX 2
Trend Projections
Graph: Actual vs Fitted Line
100

90
Trend Line 89

85

80 78

74
Yield (%)

70 70

66

61
60
54
51
50
45
Actual demand line
40
100 110 120 130 140 150 160 170 180 190
Tem p (Deg C)

Actual Data Predited Values


Seasonal Variations

Month Sales Average Average Seasonal


Two-Year Monthly Index
Demand Demand Demand
Year Year
1 2
Jan 80 100 90 94 0.957
Feb 75 85 80 94 0.851
Mar 80 90 85 94 0.904
Apr 90 110 100 94 1.064
May 115 131 123 94 1.309
… … … … … …
Total of Average Demand = 1,128 1128/12
Seasonal Index:
= Average 2 -year demand/Average monthly demand
If total demand/year for year 3=1200, then
monthly forecast= (1200/12)* seasonal index
Month Sales Average Average Seasonal
Two-Year Monthly Index
Demand Demand Demand
Year Year
1 2
Jan 80 100 90 94 0.957 95.7
Feb 75 85 80 94 0.851 85.1
Mar 80 90 85 94 0.904 90.4
Apr 90 110 100 94 1.064 106.4
May 115 131 123 94 1.309 130.9
… … … … … …
Total of Average Demand = 1,128 1128/12
Seasonal Index:
= Average 2 -year demand/Average monthly
demand

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