Partial Correlation

- The correlation between the dependent variable

and an independent variable when the linear
effects of the other independent variables in the
model have been removed from both.

- It is related to the change in R-squared when a
variable is added to an equation.

VARIABLE SELECTION
STEPWISE METHOD
PARTIAL CORRELATION
) 1 )( 1 (
2 2
YZ XZ
YZ XZ XY
XY

=
) (
2
k n t
t
k
k
k
+
=
VARIABLE SELECTION
STEPWISE METHOD
Forward Selection

- Variables are sequentially entered into the model

- Start with the largest positive or negative correlation with the
dependent variable

- The variable is entered into the equation only if it satisfies the
criterion for entry.

- The independent variable not in the equation that has the largest
partial correlation is considered next.

- The procedure stops when there are no variables that meet the
entry criterion.
Backward Elimination

- All variables are entered into the equation and then sequentially
removed.

- The variable with the smallest partial correlation with the
dependent variable is considered first for removal.

- If it meets the criterion for elimination, it is removed.

- The variable remaining in the equation with the smallest partial
correlation is considered next.

- The procedure stops when there are no variables in the equation
that satisfy the removal criteria.

VARIABLE SELECTION
STEPWISE METHOD
Criterion for entry
Probability of F = .05

Criterion for removal
Probability of F = 0.1
VARIABLE SELECTION
STEPWISE METHOD
k) - (N / variation d unexplaine
1) - (k / variation explained
, 1
=
k N k
F
EXERCISE 2
OUTLET QUANTITY PRICE ADVERTISING AVE. INCOME
1 42,100 11.77 46,100 38,000
2 55,500 9.96 47,200 39,100
3 71,100 12.36 60,900 40,100
4 63,200 12.49 55,600 44,200
5 77,200 10.68 64,400 41,800
6 70,900 12.07 60,700 44,800
7 55,600 11.97 52,100 39,900
8 70,700 11.23 57,900 43,600
9 71,400 11.26 55,600 41,700
10 79,400 9.79 60,100 41,200
11 60,600 12.29 50,700 44,000
12 50,800 12.70 46,500 43,300
13 61,800 12.33 58,600 41,000
14 40,500 10.88 42,800 38,300
15 85,300 10.14 64,800 42,100
STEP 1 2 3
CONSTANT -32655.0 817.6 -33301.7
ADVERTISING 1.75
(9.43)
1.69
(10.19)
1.45
(9.59)
PRICE -2618
(-2.20)
-4042
(-3.88)
INCOME 1.53
(2.98)
SEE 4883 4290 3333
R
2
.8723 .9090 .9497
*t-ratio in parenthesis
Log Q = -13.6 - 0.67 log P + 1.29 log ADV + 1.15 log Y
(-4.22) (-3.35) (9.09) (3.08)
SEE = 0.05795 R
2
= .946
Comment on the differences between the above regression
estimates. Which is the best model specification ?
EXERCISE 3
A travel agency conducted a study on the demand for holiday packages
to South Korea. Using monthly data over the period of January 2009 to
November 2011, the agency obtained the following estimation results.




R
2
= 0.91, SEE = 0.21, DW = 2.23, (Figures in the parentheses are the
standard errors of the coefficients.)
where:
Q is the number of tour packages being demanded
P
K
is the average price of tour package (P
k
= 3.8)
P
c
is the average price of other competitors (P
c
= 2.5)
I is per capita income (I = 30)
A is the advertising expenditure (A = 2)

(0.71) (0.23) (2.82) (0.85)
6 . 1 01 . 1 76 . 1 23 . 2 5 . 20

A I P P Q
C K
+ + + =
1. Determine which variables are statistically significant at 5
percent level.
2. Is there a serial correlation problem?
3. Can the above regression equation be accepted?
4. Construct the demand curve equation.
5. Determine the change in quantity demanded if the income
level increases by 5 percent.
6. Is it advisable to increase the advertising expenditure in
order to increase sales?
7. What price should be charged if the manager wants to
maximize total revenue?
8. Is it possible to increase revenue by reducing the price of the
tour package?
9. Can the holiday package be categorized as a normal good?
10. At the total revenue maximizing price, construct the range
of quantity demanded at 95 percent confidence interval.

FORECASTING
Predicting outcomes by extrapolating past
behavior into the future

Forecasting technique: qualitative vs. quantitative
Expert opinion
Individual experts
Panel consensus : steamroller and bandwagon
Delphi method
Survey


Forecasting model: structural vs. nonstructural
Time series vs. barometric analysis

Time-series patterns:
Stationary
Trend (long-run pattern)
Cyclical fluctuation (expansion or contraction of economy)
Seasonal variation (demand cycle)
Random fluctuations

FORECASTING
FORECASTING ERROR
Mean Absolute Deviation


Mean Absolute Percent Error

=
i
i i
Y Y
n
MAD

1

=
i
i
i i
Y
Y Y
n
MAPE

100
Mean Square Error



Root Mean Square Error
FORECASTING ERROR
( )

=
i
i i
Y Y
N
MSE
2

1
MSE RMSE =
STATIONARY MODELS
Moving average



Weighted moving average

k
Y Y Y
Y
k t t t
t
1 1
1

+
+
+ + +
=

1 1 2 1 1

+ +
+ + + =
k t k t t t
Y Y Y Y e e e
1 , 1 0
1
= s s

= i
i i
e e
Exponential smoothing





Initialization:

STATIONARY MODELS
)

(

1 t t t t
Y Y Y Y + =
+
o
k t
k
t t t t
Y Y Y Y Y
+
+ + + + = ) 1 ( ) 1 ( ) 1 (

2
2
1 1
o o o o o o o
1 0 s so
1 1

Y Y =

Where



Initialization:

STATIONARY MODELS
with Additive Seasonal Effects
p n t t n t
S E Y
+ +
+ =

1 0 , 1 0 s s s s | o
p t t t t
t p t t t
S E Y S
E S Y E

+ =
+ =
) 1 ( ) (
) 1 ( ) (
1
| |
o o
p
Y
E
p
i
i
t

=
=
1
t t t
E Y S =

Where



Initialization:

STATIONARY MODELS
with Multiplicative Seasonal Effects
p n t t n t
S E Y
+ +
=

1 0 , 1 0 s s s s | o
p t t t t
t p t t t
S E Y S
E S Y E

+ =
+ =
) 1 ( ) / (
) 1 ( ) / (
1
| |
o o
p
Y
E
p
i
i
t

=
=
1
t t t
E Y S / =
TREND MODEL
DOUBLE MOVING AVERAGE
Moving average for past k time periods (incl. t)

Double moving average for past k time periods
(incl. t)

Forecasting function:

where
k Y Y Y M
k t t t t
/ ) ... (
1 1 +
+ + + =
k M M M D
k t t t t
/ ) ... (
1 1 +
+ + + =
t t n t
nT E Y + =
+

) 1 /( ) ( 2
2
=
=
k D M T
D M E
t t t
t t t
Forecasting function:

where


Initialization:

TREND MODEL
DOUBLE EXPONENTIAL SMOOTHING
(Holts Method)
t t n t
nT E Y + =
+

1 1
1 1
) 1 ( ) (
) )( 1 (


+ =
+ + =
t t t t
t t t t
T E E T
T E Y E
| |
o o
t t
Y E = 0 =
t
T
Forecasting function

where



Initialization:

TREND MODEL
HOLT-WINTERS METHOD FOR
ADDITIVE SEASONAL EFFECTS
p n t t t n t
S nT E Y
+ +
+ + =

p t t t t
t t t t
t t p t t t
S E Y S
T E E T
T E S Y E

+ =
+ =
+ + =
) 1 ( ) (
) 1 ( ) (
) )( 1 ( ) (
1 1
1 1

| |
o o
p
Y
Y S
p
i
i
t t

=
=
1
Forecasting function

where



Initialization:

TREND MODEL
HOLT-WINTERS METHOD FOR
MULTIPLICATIVE SEASONAL EFFECTS
p n t t t n t
S nT E Y
+ +
+ = ) (

p t t t t
t t t t
t t p t t t
S E Y S
T E E T
T E S Y E

+ =
+ =
+ + =
) 1 ( ) / (
) 1 ( ) (
) )( 1 ( ) / (
1 1
1 1

| |
o o
p
Y
Y
S
p
i
i
t
t

=
=
1
TREND MODEL
REGRESSION ANALYSIS
Linear :

Quadratic :


Exponential :
t Q
t 1 0
| | + =
2
2 1 0
t t Q
t
| | | + + =
0
0
2
2
<
>
|
|
t
t
r Q
0
| =
1
1
<
>
r
r
r t Q
t
log log log
0
+ = |
Example:






REGRESSION ANALYSIS
r t Q
t
log log log
0
+ = |
t Q
t
067 . 0 498 . 3 log + =
t
t
Q ) 17 . 1 ( 75 . 147 , 3 =
gt
t
e Q Q
0
=
t
t
r Q
0
| =
gt Q Q
t
+ =
0
ln ln
t Q
t
154 . 0 054 . 8 ln + =
t Q
t
) 17 . 1 ( 35 . 146 , 3 + =
If p = 4, and using quadratic trend model,

TREND ANALYSIS
with Seasonal Regression
3 5 2 4 1 3
2
2 1 0
s s s t t Y
t
| | | | | | + + + + + =