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11
Exponential Smoothing Models
Simple exponential smoothing
model
Alpha is the smoothing constant
Whenever appropriate more weight
can be given to the more recent
data (time periods)
Double exponential smoothing
(Holts model)
Adds trend component, T and delta
(gamma) as the smoothing constant
for trend
Forecast Including Trend (FIT)
Excel time!
Problem 20, continued.
) F A ( F F
1 1 1
+ =
t t t t
o
1 0 where s so
) FIT F ( T T
1 1
+ =
t t t t
o
) FIT A ( FIT F
1 1 1
+ =
t t t t
o
t t t
T F FIT + =
12
Measuring Accuracy, Forecast Errors
To compare different time series techniques or to select the
best set of initial values for the parameters, use a combination
of the the following four metrics:
Mean Absolute Deviation
Most popular but
Mean Absolut Percent Error
Should be used in tandem with MAD
Mean Square Error
Root Mean Square Error
n
F A
= MAD
1
=
n
i
i i
n
i
i
i i
n
1
A
F A
100
= MAPE
( )
n
F A
= MSE
1
2
=
n
i
i i
MSE RMSE=
13
Tracking Signal
The Tracking Signal or TS is a measure that indicates
whether the forecast average is keeping pace with any
genuine upward or downward changes in demand.
Depending on the number of MADs selected, the TS can be
used like a quality control chart indicating when the model
is generating too much error in its forecasts.
TS is a monitoring system.
The TS formula is:
Deviation Absolute Mean
Errors Forecast of Sum Running
= TS
14
Regression analysis
Identify factors (independent variables) that can be used to
predict the values for the forecast variable (e.g., sales).
Regression applied to causal data requires different kinds of
data
Regression applied to time series data is also know as
trend line analysis
We will use Excel (Tools/Data analysis) to obtain the
regression line and all relevant statistics.
15
A simple regression example
The first example applies regression to time series data.
Whenever possible, plot and observe the data.
The scatter plot shows a linear relation between advertising and
sales. So the following regression model is suggested by the data,
which refers to the true relationship between the entire population of
advertising and sales values.
Other common formats are:
i
i
c | | + + =
1 1 0 i
X Y
t b a Y
X b a Y
+ =
+ =
16
Decomposition of a Time Series
Demand has both trend and seasonal components.
View data via Excel.
1. Compute overall average
2. Compute average of the same seasons of each cycle (e.g., year)
3. Compute seasonal indexes (seasonal averages / overall avg.)
4. Deseasonalize data (actual values /seasonal indexes)
5. Apply regression to deseasonalized data
6. Compute (project) deseasonalized forecasts using the regression
equation
7. Reseasonalize the forecasts by multiplying them with the
seasonal indexes.
Excel time.
Problem 21.
17
Multiple regression
Most regression problems involve more than one independent
variable.
If each independent variables varies in a linear manner with Y, the
estimated regression function in this case is:
Where b
0
is the intercept (also called constant)
The optimal values for the b
i
(slopes) can again be found using the
least squares method
k k
b b b b X X X Y
2 2 1 1 0
+ + + + =
18
Steps in multiple regression analysis
1. Hypotheses for testing whether a general linear model is useful is
predicting Y:
1. H
o
:
1
=
2
=
3
= ... =
k
= 0 (means there is NOTHING useful)
2. H
A
: At least one of the parameters in H
o
is nonzero.
2. Test statistic: F-statistic = MSR / MSE
3. If the model is deemed adequate (passes the F-test; rejected H
0
)
then go to step 4 (otherwise, none of variables have any impact on Y )
4. Conduct t-tests (significance tests) on parameters (slopes).
5. Remove the most insignificant independent variable, re-run the
regression, and go to step 4.
6. Repeat steps 4 & 5 until all remaining independent variable
parameters (slopes) are significant, then go to step 7
7. If the intercept (
0
) is insignificant then remove it, run regression one
more time.
Excel time!
19
What Forecasters Should Do
Determine what elements of historical data provide repeatable
patterns and utilize this to make extrapolations.
Make a list of the possible independent variables that may have
influenced the historical data and may influence future
outcomes.
Statistically correlate the independent variables to the outcome
history using regression analysis to validate their importance
and to calibrate their effects.
Make estimates of forecast error wherever possible using MAD
or standard deviation measures.
Make clear presentations of the results and assumptions and
listen to feedback.
20
Forecasting
Always remember that you (managers) are decision makers and
sound decisions are based on good forecasts
Suggested problems:
2, 3, 4, 7, 11, 12, 14, 17, 20, 21, 27