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.
