Business Analytics and

Decision Making
Lecture 3
Time series analysis and Linear Regression
Time Series Analysis and
Forecasting
 Quantitative Approaches to Forecasting

 Time Series Patterns

 Forecast Accuracy

 Moving Averages and Exponential Smoothing

Quantitative Forecasting Methods

 Quantitative methods are based on an analysis of

historical data concerning one or more time series.
 A time series is a set of observations measured at
successive points in time or over successive periods
of time.
 If the historical data used are restricted to past
values of the series that we are trying to forecast, the
procedure is called a time series method.
Time Series Plot

 A useful first step in identifying the underlying pattern

in the data is to construct a time series plot.

 A time series plot is a graphical presentation of the

relationship between time and the time series
variable.

 Time is on the horizontal axis, and the time series

values are shown on the vertical axis.
Time Series Plot

 Example
 Time Series Patterns

 The common types of data patterns that can be

identified when examining a time series plot include:

Horizontal

Trend (upward or downward)

Seasonal

Trend & Seasonal

Cyclical
 
Time Series Patterns
Cyclical Pattern

• A cyclical pattern exists if the time series plot shows an alternating sequence of
points below and above the trend line lasting more than one year.
• Often, the cyclical component of a time series is due to multiyear business cycles.
• Business cycles are extremely
difficult, if not impossible, to
forecast.
• In this chapter we do not deal
with cyclical effects that may be
present in the time series.
 Forecast Accuracy

 The key concept associated with measuring forecast

accuracy is forecast error.

Forecast Error = Actual Value - Forecast

 A positive forecast error indicates the forecasting

method underestimated the actual value.
 A negative forecast error indicates the forecasting
method overestimated the actual value.
 Forecast accuracy and errors

• Let’s represent the actual data at time t by Y t and the forecasted

data at time t by Ft :
E1 = Does not exist
E2 = Y2 – F2
E3 = Y3 - F3
…

Et = Yt – Ft
• Mean Forecast Error (MFE):

Where k is the number of periods for which we do not have a forecasted

value and n is the total number of periods.
In our previous example, k = 1 and n = 12 MFE =
MFE = 5/11 = 0.45

• Mean Absolute error (MAE):

How is it different from MFE?

In our previous example, MAE = 41/11 = 3.73

• Mean square Error (MSE):
In our previous example MSE = 179/11 = 16.27

Which one is more reliable? MSE or MAE? We see a huge difference!!

• Mean Absolute percentage error (MAPE):

Percent error for each forecast is calculated
through

In our previous example MAPE = 211.69/11 = 19.24%

• Lets consider two methods of forecasting:

1- using the average of all previous periods

As a value for the new period
What method has generated less error?
Moving Averages and Exponential Smoothing
 Now we discuss three forecasting methods that
are appropriate for a time series with a horizontal
pattern:

Moving Averages Exponential Smoothing

 They are called smoothing methods because their

objective is to smooth out the random fluctuations
in the time series.
 They are most appropriate for short-range
forecasts.
Moving Averages

The moving averages method uses the average

of the most recent k data values in the time series.
As the forecast for the next period.
^
𝑌 𝑡 +1=
∑ ( most recent 𝑘data values ) 𝑌 𝑡 +𝑌 𝑡 −1 + …+𝑌 𝑡 − 𝑘+1
=
𝑘 𝑘

where: = forecast of the time series for period t + 1

Each observation in the moving average

calculation receives the same weight.
 Moving Averages

 The term moving is used because every time a new

observation becomes available for the time series, it
replaces the oldest observation in the equation.
 As a result, the average will change, or move, as
new observations become available.
Example: Moving Average

 Example: Rosco Drugs

If Rosco Drugs uses a 3-period moving average to
forecast sales, what are the forecasts for weeks 4-11?

Week Sales Week Sales

1 110 6 120
2 115 7 130
3 125 8 115
4 120 9 110
5 125 10 130
Example: Moving Average

Week Sales 3MA Forecast

1 110
2 115 (110 + 115 + 125)/3
3 125
4 120 116.7
5 125 120.0
6 120 123.3
7 130 121.7
8 115 125.0
9 110 121.7
10 130 118.3
11 118.3
 Example: Moving Average

3MA Forecast Absolute Squared Abs.%

Week Sales Forecast Error Error Error Error
1 110
2 115
3 125
4 120 116.7 3.3 3.3 10.89 2.75
5 125 120.0 5.0 5.0 25.00 4.00
6 120 123.3 -3.3 3.3 10.89 2.75
7 130 121.7 8.3 8.3 68.89 6.38
8 115 125.0 -10.0 10.0 100.00 8.70
9 110 121.7 -11.7 11.7 136.89 10.64
10 130 118.3 11.7 11.7 136.89 9.00
Total 6.6 53.3 489.45 44.22
Example: Moving Average

 3-MA Forecast Accuracy

53.3
MAE= =7.61
7
489.45
MSE= =69.92
7
44.22
MAPE = =6.32 %
7

The 3-week moving average approach provided

more accurate forecasts than the naïve approach.
 Exponential Smoothing
Exponential smoothing

• The exponential smoothing forecast is a weighted

average of all the observations in the time series.

• The term exponential smoothing comes from the

exponential nature of the weighting scheme for the
historical values.
Exponential Smoothing

• Exponential Smoothing Forecast

^ =𝛼 𝑌 + ( 1− 𝛼 ) 𝑌
𝑌 ^
𝑡 +1 𝑡 𝑡

where:
= forecast of the time series for period t + 1
Yt = actual value of the time series in period t
Ft = forecast of the time series for period t
a = smoothing constant (0 < a < 1)
and let:
^ =𝑌 (¿ initiate the computations)
𝑌 2 1
 Example: Exponential Smoothing

 Example: Rosco Drugs

If Rosco Drugs uses exponential smoothing
to forecast sales, which value for the smoothing
constant , .1 or .8, gives better forecasts?

Week Sales Week Sales

1 110 6 120
2 115 7 130
3 125 8 115
4 120 9 110
5 125 10 130
Example: Exponential Smoothing

 Using Smoothing Constant Value  = .1

= Y1 = 110
= .1Y2 + .9 = .1(115) + .9(110) = 110.50
= .1Y3 + .9 = .1(125) + .9(110.5) = 111.95
= .1Y4 + .9 = .1(120) + .9(111.95) = 112.76
= .1Y5 + .9 = .1(125) + .9(112.76) = 113.98
= .1Y6 + .9 = .1(120) + .9(113.98) = 114.58
= .1Y7 + .9 = .1(130) + .9(114.58) = 116.12
= .1Y8 + .9 = .1(115) + .9(116.12) = 116.01
= .1Y9 + .9 = .1(110) + .9(116.01) = 115.41
 Example: Exponential Smoothing

 Using Smoothing Constant Value  = .8

= = 110
= .8(115) + .2(110) = 114.00
= .8(125) + .2(114) = 122.80
= .8(120) + .2(122.80) = 120.56
= .8(125) + .2(120.56) = 124.11
= .8(120) + .2(124.11) = 120.82
= .8(130) + .2(120.82) = 128.16
= .8(115) + .2(128.16) = 117.63
= .8(110) + .2(117.63) = 111.53
 Example: Exponential Smoothing (a = .1)

a = .1 Forecast Absolute Squared Abs.%

Week Sales Forecast Error Error Error Error
1 110
2 115 110.00 5.00 5.00 25.00 4.35
3 125 110.50 14.50 14.50 210.25 11.60
4 120 111.95 8.05 8.05 64.80 6.71
5 125 112.76 12.24 12.24 149.94 9.79
6 120 113.98 6.02 6.02 36.25 5.02
7 130 114.58 15.42 15.42 237.73 11.86
8 115 116.12 -1.12 1.12 1.26 0.97
9 110 116.01 -6.01 6.01 36.12 5.46
10 130 115.41 14.59 14.59 212.87 11.22
Total 82.95 974.22 66.98
 Example: Exponential Smoothing (a = .1)

 Forecast Accuracy
82.95
MAE= =9.22
9
974.22
MSE= =108.25
9
66.98
MAPE= =7.44 %
9

Exponential smoothing (with a = .1) provided

less accurate forecasts than the 3-MA approach.
 Example: Exponential Smoothing (a = .8)

a = .8 Forecast Absolute Squared Abs.%

Week Sales Forecast Error Error Error Error
1 110
2 115 110.00 5.00 5.00 25.00 4.35
3 125 114.00 11.00 11.00 121.00 8.80
4 120 122.80 -2.20 2.20 7.84 1.83
5 125 120.56 4.44 4.44 19.71 3.55
6 120 124.11 -4.11 4.11 16.91 3.43
7 130 120.82 9.18 9.18 84.23 7.06
8 115 128.16 -13.16 13.16 173.30 11.44
9 110 117.63 -7.63 7.63 58.26 6.94
10 130 111.53 18.47 18.47 341.27 14.21
Total 75.19 847.52 61.61
Example: Exponential Smoothing (a = .8)

 Forecast Accuracy
75.19
MAE= =8.35
9
847.52
MSE= =94.17
9
61.61
MAPE= =6.85 %
9
Exponential smoothing (with a = .8) provided
more accurate forecasts than ES with a = .1,
but less accurate than the 3-MA.