9 September, 2008 Forecasting with Casual Quantitative Models: Forecasting with a regression Model 1.

One independent variable, Y=a+bx 2. Two independent variables, Y=a+b1X1+b2X2 Examples: (1)A firms sales for a particular line during the 12 quarters of the past three years were as follows: Quart er Sales 1 600 2 155 0 3 150 0 4 150 0 5 240 0 6 310 0 7 260 0 8 290 0 9 380 0 10 450 0 11 400 0 12 490 0

(a)The firm wants to forecast each quarter of the fourth year-that is, quarters 13, 14, 15 and 16 (b) Standard error of estimate. (c) Coefficient of determination. (2) The following table represents the yearly food expenditure, annual income and family size of 6 families. Yearly food expenditu re: Annual income(in 000 Rs.) Family size: 25 30 25 32 20 21

10

12

14

15

10

11

(a) Fit the regression equation that best describe the data. (b) Compute the standard error of estimate. (c) Compute coefficient of multiple determination.

10 september,2008 Reliability of Forecasting: Reliability of forecasting is based on the measurement of error. Error refers to the difference between the forecast value and Actual Value. Sources of error: Bias errors and Random errors-Bias error occur in case forecast repeatedly overestimates or underestimates the actual demand, there by prevailing consistent mistake.Hence, Bias indicates the dimensional tendency of forecast error. This can be computed as the ratio of the sum of the difference between Forecast demand and Actual demand to number of periods. The value of the Bias will be positive if forecast repeatedly overestimates actual demand and that of negative if underestimates consistently. Random errors are those which cannot be explained by the forecast model being used. Measurement of Errors 1. MAD (mean absolute deviation): It is an average of the absolute deviation of actual demand from forecast demand. It is useful in obtaining tracking signal. 1 standard deviation=1.25 MAD, conversely, 1 MAD=0.8 standard deviation. 2. Tracking Signal (TS): A measurement that indicates whether the forecast average is keeping pace with any genuine upward or downward changes in demand. It is computed as the ratio of RSFE (running sum of forecast error) to MAD. 3. Bias:

Note: In a perfect forecasting model, the sum of the actual forecast errors
would be 0; the errors that result in overestimates should be offset by errors that are underestimates. The tracking signal would then be 0, indicating an unbiased model, neither leading nor lagging the actual demands.

Example: Compute MAD, RSFE and TS from the following Forecast and actual Data. Month Demand Forecast Actual 1 1000 950 2 1000 1070 3 1000 1100 4 1000 960 5 1000 1090 6 1000 1050

Also, Show the drift of Tracking Signal by plotting on a graph and comment on it.

Practice:
1. A specific forecasting model was used to forecast demand for a product. The forecasts and the corresponding demand that subsequently occurred are shown below; Use the MAD and Tracking signal technique to evaluate the accuracy of the forecasting model. Month Actual Forecast October 700 660 Novembe r 760 840 Decembe r 780 750 January 790 835 February 850 910 March 950 890

Ans: MAD=52.5 and Tracking signal=-1.05, this is not enough evidence to reject the forecasting model, so we accept its recommendations. 2. From the given information calculate forecast for the year 2009 using =0.1 and =0.2 and for year 2005 was 195 units. Discuss the suitability of Value of . Year Actual demand 2006 200 2007 110 2008 300

Hint: The Demand for year 2009 can be calculated by exponential smoothing using two different value of and the suitability of can be determined by comparing MAD and Tracking Signal. Ans: (a) Forecast for 2009 using =0.1 is 205.95 ant at =0.2 is 203.04 units.

(b) At =0.1, MAD=67.85 and TS=0.479; At =0.2, MAD=70.9 and TS=0.575 Conclusion: MAD is lower when =0.1.So,=0.1 is selected if MAD is only considered.However,it is better to determine the suitability based on TS.So,=0.2 is a good choice.