TrendModels

Atrendmodelis
Tt = g (Timet )

whereTimet isthetimeindex. InSTATA,Timet isanintegersequence,normalizedto bezeroatfirstobservationof1960. Mostcommonmodels

LinearTrend ExponentialTrend QuadraticTrend TrendswithChangingSLope

Warning: BeskepticalofTrendModels
Whileinsomecases,trendforecastingcanbe useful. Inmanycases,itcanbehazardous. Wewillexaminesomeofthetrendexamples inChapter5ofDieboldstext Theydidnotforecastwelloutofsample. Aconstructivealternativeistoforecastgrowth rates,aswedidforconsumptionexpenditure.

Example1 LaborForceParticipationRate
FromBLS Monthly,19482009,Seasonallyadjusted MenandWomen,ages25+ Percentageofpopulationinlaborforce(employed plusunemployeddividedbypopulation) Dieboldestimateson19481992 Wewillestimateon19481992,forecast19932009

WomensLaborParticipationRate 19481992

MensLaborParticipationRate 19481992

LinearTrendModel
Thelaborforceparticipationrateshavebeen smoothlyandlinearlyincreasing(forwomen) andsmoothlyandlinearlydecreasing(for men)over19481992 Thissuggestsalineartrend
Tt = 0 + 1Timet

Inthismodel,1 istheexpectedperiodto periodchangeinthetrendTt

Example2 RetailSales,CurrentDollars
FromCensusBureau Monthly,19552001,seasonallyadjusted
Thisparticularseriesdiscontinuedafter2001

Dieboldestimatesupto1991 Wewillforecast1992current

RetailSales 19551993

QuadraticTrends
Theretailsalesserieshasbeenincreasing smoothlyover19551993,butnotlinearly. Tomodelthiswewilluseaquadratictrend Tt = 0 + 1Timet + 2Timet2

Example3 TransactionVolume,S&PIndex
FromYahooFinance (SimilartoNYSEseriesinDiebold) Weekly,1950current Dieboldestimateson19551993,forecasts1994 Wewillforecast19942001

TransactionVolume

ExponentialTrend
Tomodelthiswewilluseanexponentialtrend
Tt = e 0 + 1Timet

Theexponentialtrendislinearaftertaking (natural)logarithms
ln (Tt ) = 0 + 1Timet

Thisistypicallyestimatedbyalinearmodelafter takinglogsofthevariabletoforecast

Ln(Volume)

Inlogarithms,trendisroughlylinear.

ExponentialTrends
Mosteconomicserieswhicharegrowing (aggregateoutput,suchasGDP,investment, consumption)areexponentiallyincreasing
Percentagechangesarestableinthelongrun

Theseseriescannotbefitbyalineartrend Wecanfitalineartrendtotheir(natural) logarithm

LinearModels
Thelinearandquadratictrendsarebothlinear regressionmodelsoftheform
t = 0 + 1 x1t

or
t = 0 + 1 x1t + 2 x2t

where
x1t =Timet x2t =Timet2

Example4 RealGDP
FromBEA Quarterly,19472009 Wewillestimateon19471990,forecast1991 2009 Alsouseanexponentialtrend

RealGDP

Ln(RealGDP)

LinearForecasting
Thegoalistoforecastfutureobservations givenalinearfunctionofobservables Inthecaseoftrendestimation,these observablesarefunctionsofthetimeindex Inothercases,theywillbeotherfunctionsof thedata Inthemodel t = 0 + 1 xt theforecastforyt+h ist+h=b0+b1xtwhereb0 andb1 areestimates

Estimation
Howshouldweselectb0 andb1 ? Thegoalistoproduceaforecastwithlow meansquareerror(MSE) Thebestlinearforecastisthelinearfunction
0+1xtthatminimizestheMSE
t + h ) = E ( y t + h 0 1 xt ) E ( y t +h y
2 2

WedonotknowtheMSE,butwecan estimateitbyasampleaverage

SumofSquaredErrors
Sampleestimateofmeansquareerroristhesumof squarederrors
1 n 2 S n ( 0 , 1 ) = ( yt + h 0 1 xt ) n t =1

Thebestlinearforecastisthelinearfunction0+1xt thatminimizestheMSE,orexpectedsumofsquared errors. Oursampleestimateofthebestlinearforecastisthe linearfunctionwhichminimizesthe(sample)sumof squarederrors. Thisiscalledtheleastsquaresestimator

LeastSquares
Theleastsquaresestimates(b0,b1)arethe valueswhichminimizethesumofsquared errors 1 n 2 S n ( 0 , 1 ) = ( yt + h 0 1 xt )
n
t =1

Thisproducesestimatesofthebestlinear predictor thelinearfunction0+1xtthat minimizestheMSE

MultipleRegressors
Therearemultipleregressors
t = 0 + 1 x1t + 2 x2t

Forexample,thequadratictrend
Tt = 0 + 1Timet + 2Timet2

Thebestlinearpredictoristhelinearfunction 0+1x1t+2x2tthatminimizestheMSE
t + h ) = E ( y t + h 0 1 x1t 2 x2t ) E( y t +h y
2 2

MultipleRegression
Thesampleestimateofthebestlinear predictorarethevalues(b0,b1,b2)which minimizethesumofsquarederrors
1 n 2 S n ( 0 , 1 , 2 ) = ( yt + h 0 1 x1t 2 x2t ) n t =1

InSTATA,usetheregress command

Example1 WomensLaborForceParticipationRate

RegressionEstimation

InSampleFit

Residuals
Residualsaredifferencebetweendataand fittedregressionline
t = yt + h Tt e = yt + h b0 b1Timet

ResidualPlot

InSampleFit

Computewithpredict command Fitlooksgood

Forecast
Forecastisthelinearfunctionwithestimated coefficients

TT + h = b0 + b1TimeT + h
Computewithpredict command

ForecastIntervals
Computeresiduals
t = yt + h t e = yt + h b0 b1Timet

Computequantiles ofresiduals
Theseareconstantovertime

Addtopredictedvalues
Identicaltoconstantmeancase

OutofSampleForecast

Outofsamplepredictionmightbetoolow.

OutofSample WomensLaborForceParticipation

No:Predictionwaswaytoohigh!

MensLaborForceParticipationRate

Estimation

InSampleFit

Residuals

Forecast

EndofSamplelooksworrying

OutofSample MensLaborForceParticipation

LinearTrendTerrible

Example2 RetailSales

LinearandQuadraticTrend

LinearandQuadraticTrend

Forecast

Residuals

ActualValues

Example3:Volume

EstimatingLogarithmicTrend

FittedTrend

Residuals

Forecast

OutofSample

ForecastingLevelsfromaForecastofLogs
LetYt beaseriesandyt=ln(Yt)itslogarithm Supposetheforecastforthelogisalineartrend: E(yt+h | t)=Tt =0+ 1 Timet ThenaforecastforYt isexp(Tt) If[LT ,UT]isaforecastintervalforyT+h Then[exp(LT),exp(UT)]isaforecastintervalfor YT+h Inotherwords,justtakeyourpointandinterval forecasts,andapplytheexponentialfunction.
InSTATA,usegenerate command

ForecastinLevels

OutofSample

Example4:RealGDP

Ln(RealGDP)

Estimation

FittedTrend

Residuals

Forecastofln(RGDP)

ForecastofRGDP(inlevels)

OutofSample

ProblemswithTrendForecasts
Trendforecastsunderstateuncertainty Actualuncertaintyincreasesatlongforecast horizons. Shorttermtrendforecastscanbequitepoor unlesstrendlinedupcorrectly Longtermtrendforecastsaretypicallyquite poor,astrendschangeoverlongtimeperiods Itispreferredtoworkwithgrowthrates,and reconstructlevelsfromforecastedgrowthrates (moreonthislater).

TrendModels
IhopeIveconvincedyoutobeskepticalof trendbasedforecasting. Theproblemisthatthereisnoeconomic theoryforconstanttrends,andchangesin thetrendfunctionarenotapparentbefore theyoccur. Itisbettertoforecastgrowthrates,andbuild levelsfromgrowth.

FinalTrendForecast WorldRecord 100metersprint