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FORECASTING TECHNIQUES

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FORECASTING TECHNIQUES

Forecasting is the process of making statements about events whose actual outcomes (typically) have not yet been observed. Prediction is a similar. rolling mean or running average.g. Given a series of numbers and a fixed subset size.[4] Moving average weighted moving average Exponential smoothing Autoregressive moving average (ARMA) Autoregressive integrated moving average (ARIMA)e. or alternatively to less formal judgemental methods METHODS: TIME SERIES METHODS Time series methods use historical data as the basis of estimating future outcomes. a moving average. • • • • • • • • • • Rolling forecast is a projection into the future based on past performances. cross-sectional or longitudinal data. A commonplace example might be estimation of the expected value for some variable of interest at some specified future date. also called rolling average. This process is repeated over the . which is averaged. Box-Jenkins Extrapolation Linear prediction Trend estimation Growth curve MOVING AVERAGE: In statistics. the moving average can be obtained by first taking the average of the first subset. but more general term. routinely updated on a regular schedule to incorporate data. is a type of finite impulse response filter used to analyze a set of data points by creating a series of averages of different subsets of the full data set. Both might refer to formal statistical methods employing time series. creating a new subset of numbers. The fixed subset size is then shifted forward.

like 10 days. . each of which is the average of the corresponding subset of a larger set of data points. In any case moving average levels are interpreted as support in a rising market. In technical analysis there are various popular values for n. meaning a full summation each time is unnecessary. the average price at the time of the transaction can be calculated for all of the transactions up to that point using the cumulative average. [citation needed] For example. The plot line connecting all the (fixed) averages is the moving average. 40 days. a moving average is not a single number. A moving average may also use unequal weights for each data value in the subset to emphasize particular values in the subset.[citation needed] This article uses the term cumulative moving average or simply cumulative average since this term is more descriptive and unambiguous. such as short. an investor may want the average price of all of the stock transactions for a particular stock up until the current time. or resistance in a falling market. This is the cumulative average. SIMPLE MOVING AVERAGE: A simple moving average (SMA) is the unweighted mean of the previous n data points.. CUMULATIVE MOVING AVERAGE The cumulative moving average[citation needed] is also frequently called a running average or a long running average[citation needed] although the term running average is also used as synonym for a moving average. or long term. a 10-day simple moving average of closing price is the mean of the previous 10 days' closing prices. or 200 days. the data arrives in an ordered data stream and the statistician would like to get the average of all of the data up until the current data point. The period selected depends on the kind of movement one is concentrating on. As each new transaction occurs.. intermediate. For example. xi up to the current time: . a new value comes into the sum and an old value drops out.entire data series. Thus. If those prices are then the formula is When calculating successive values.. In some data acquisition systems. which is typically an unweighted average of the sequence of i values x1. but it is a set of numbers.

The error terms are generally assumed to be independent. An ARIMA(p. identically distributed variables sampled from a normal distribution with zero mean.q) model is given by: where L is the lag operator. Assume now that the polynomial Then it can be rewritten as: has a unitary root of multiplicity d. using the formula:[citation needed] where CA0 can be taken to be equal to 0. They are applied in some cases where data show evidence of non-stationarity.d. the αi are the parameters of the autoregressive part of the model. where an initial differencing step (corresponding to the "integrated" part of the model) can be applied to remove the non-stationarity.The brute force method to calculate this would be to store all of the data and calculate the sum and divide by the number of data points every time a new data point arrived. it is possible to simply update cumulative average as a new value xi+1 becomes available. and is given by: . and in particular in time series analysis. These models are fitted to time series data either to better understand the data or to predict future points in the series (forecasting). then an ARMA(p. Definition Given a time series of data Xt where t is an integer index and the Xt are real numbers.q) process expresses this polynomial factorisation property. an autoregressive integrated moving average (ARIMA) model is a generalization of an autoregressive moving average (ARMA) model. However. the θi are the parameters of the moving average part and the are error terms. AUTOREGRESSIVE INTEGRATED MOVING AVERAGE : In statistics and econometrics.

The differences are found in the way the parameters ai are chosen. These equations are valid for all types of (one-dimensional) linear prediction. In system analysis (a subfield of mathematics). The error generated by this estimate is where x(n) is the true signal value.q) process having the autoregressive polynomial with some roots in the unity. The most common representation is where is the predicted signal value. In digital signal processing. For multi-dimensional signals the error metric is often defined as where is a suitable chosen vector norm. and ai the predictor coefficients. linear prediction is often called linear predictive coding (LPC) and can thus be viewed as a subset of filter theory. For this reason every ARIMA model with d>0 is not wide sense stationary. linear prediction can be viewed as a part of mathematical modelling or optimization. x(n − i) the previous observed values.and thus can be thought as a particular case of an ARMA(p+d. LINEAR PREDICTION: Linear prediction is a mathematical operation where future values of a discrete-time signal are estimated as a linear function of previous samples. CAUSAL / ECONOMETRIC METHODS .

Regression models involve the following variables: • • • The unknown parameters denoted as β. Y. regression analysis estimates the conditional expectation of the dependent variable given the independent variables — that is. the variance-covariance matrix of the errors is diagonal and each non-zero element is the variance of the error. Less commonly. The predictors must be linearly independent. it must not be possible to express any predictor as a linear combination of the others. weighted least squares or other methods might be used. More specifically. X. projections of the influencing variables can be made and used in the forecast. The variance of the error is constant across observations (homoscedasticity).Some forecasting methods use the assumption that it is possible to identify the underlying factors that might influence the variable that is being forecast. . the average value of the dependent variable when the independent variables are held fixed. If this is not so. The error is assumed to be a random variable with a mean of zero conditional on the explanatory variables. sales of umbrellas might be associated with weather conditions. In all cases. that is. For example. Most commonly. or other location parameter of the conditional distribution of the dependent variable given the independent variables. In regression analysis.e. A regression model relates Y to a function of X and β. the estimation target is a function of the independent variables called the regression function. this may be a scalar or a vector. • • • Regression analysis using linear regression or non-linear regression Econometrics Autoregressive moving average with exogenous inputs (ARMAX) REGRESSION ANALYSIS: In statistics. See Multicollinearity. The variables are error-free. The dependent variable. modeling may be done using errorsin-variables model techniques. Classical assumptions for regression analysis include: • • • • • • The sample must be representative of the population for the inference prediction. The independent variables. i. the focus is on a quantile. which can be described by a probability distribution. regression analysis includes any techniques for modeling and analyzing several variables. regression analysis helps us understand how the typical value of the dependent variable changes when any one of the independent variables is varied. If the causes are understood. If not. The errors are uncorrelated. while the other independent variables are held fixed. when the focus is on the relationship between a dependent variable and one or more independent variables. it is also of interest to characterize the variation of the dependent variable around the regression function.

autoregressive moving average (ARMA) models. Sometimes the form of this function is based on knowledge about the relationship between Y and X that does not rely on the data. the form of the function f must be specified. In matrix notation. General linear model In the more general multiple regression model. That is. a flexible or convenient form for f is chosen. If no such knowledge is available. there is no β0. are typically applied to autocorrelated time series . the normal equations for k responses (usually k = 1) are written as with generalized inverse ( − ) solution. sometimes called Box-Jenkins models after the iterative Box-Jenkins methodology usually used to estimate them. The residual can be written as The normal equations are Note that for the normal equations depicted above. To carry out regression analysis.The approximation is usually formalized as E(Y | X) = f(X. subscripts showing matrix dimensions: AUTOREGRESSIVE MOVING AVERAGE MODEL: n statistics and signal processing. β). there are p independent variables: The least square parameter estimates are obtained by p normal equations. Thus in what follows.

q) model where p is the order of the autoregressive part and q is the order of the moving average part The notation ARMA(p. When looking at long term data. interactive forecasting method which relies on a panel of experts. stock prices may be shocked by fundamental information as well as exhibiting technical trending and meanreversion effects due to market participants. The experts answer questionnaires in two or more rounds. opinions and subjective probability estimates. Jenkins & Reinsel (1994) use a different convention for the autoregression coefficients. The model is usually then referred to as the ARMA(p. The model consists of two parts. Thus the ARMA model would be written as APPLICATIONS ARMA is appropriate when a system is a function of a series of unobserved shocks (the MA part)[clarification needed] as well as its own behavior. the ARMA model is a tool for understanding and. perhaps. including Box. an autoregressive (AR) part and a moving average (MA) part.Given a time series of data Xt. After each . For example. This allows all the polynomials involving the lag operator to appear in a similar form throughout. ALTERNATIVE NOTATION Some authors. predicting future values in this series. econometricians tend to opt for an Ar(p) model for simplicity JUDGMENTAL METHODS: Judgmental forecasting methods incorporate intuitive judgements. This model contains the AR(p) and MA(q) models. q) refers to the model with p autoregressive terms and q moving average terms. • • • • • • Composite forecasts Surveys Delphi method Scenario building Technology forecasting Forecast by analogy DELPHI METHOD: The Delphi method is a systematic.data.

analysis of the possibility of the earth being struck by a large celestial object (a meteor) suggests that whilst the probability is low. The objective of the method was to combine expert opinions on likelihood and expected development time. It is believed that during this process the range of the answers will decrease and the group will converge towards the "correct" answer.The analysis is designed to allow improved decision-making by allowing consideration of outcomes and their implications.[1] USE IN FORECASTING First applications of the Delphi method were in the field of science and technology forecasting. in a single indicator. especially those related to public policy issues. In this sense. One of the first such reports. The governments of Latin America and the Caribbean have successfully used the Delphi method as an openended public-private sector approach to identify the most urgent challenges for their regional ICT-for-development eLAC Action Plans.[6] As a result. For example. such as technology policies. industrial robots. academic and private sector participants of the Delphi. Other forecasts of technology were dealing with vehicle-highway systems. Quantitative methods produced errors of 10–15%. automation. Thus. such as economic trends. population control. of the particular technology. especially in a field of rapid change. stability of results) and the mean or median scores of the final rounds determine the results. SCENARIO ANALYSIS Scenario analysis is a process of analyzing possible future events by considering alternative possible outcomes (scenarios). the Delphi method can contribute to a general appreciation of participative policy-making. broadband connections. health and education.round. war prevention and weapon systems. experts are encouraged to revise their earlier answers in light of the replies of other members of their panel. intelligent internet." For example. covering such topics as scientific breakthroughs. the damage inflicted is so high that the event is much more . It was also applied successfully and with high accuracy in business forecasting. space progress. the Delphi method predicted the sales of a new product during the first two years with inaccuracy of 3–4% compared with actual sales. assessed the direction of long-term trends in science and technology development. in one case reported by Basu and Schroeder (1977). achievement of consensus. Finally. Later the Delphi method was applied in other areas. a facilitator provides an anonymous summary of the experts’ forecasts from the previous round as well as the reasons they provided for their judgments. governments have widely acknowledged the value of collective intelligence from civil society. number of rounds. The Delphi method has also been used as a tool to implement multi-stakeholder approaches for participative policy-making in developing countries.g. and traditional unstructured forecast methods had errors of about 20%. and technology in education. prepared in 1964 by Gordon and Helmer. the process is stopped after a pre-defined stop criterion (e.Scenario analysis can also be used to illuminate "wild cards.

ARTIFICIAL INTELLIGENCE METHODS : • • Artificial neural networks Support vector machines ARTIFICIAL NEURAL NETWORK An artificial neural network (ANN). It might further seek to determine correlations and assign probabilities to the scenarios (and sub-sets if any). MODELS Neural network models in artificial intelligence are usually referred to as artificial neural networks (ANNs). the Pentagon certainly had to model alternative possibilities that might arise in the war situation and had to position materiel and troops accordingly.important (threatening) than the low probability (in any one year) alone would suggest. slow growth) and it might also attempt to forecast financial market returns (for bonds. It may also perform stress testing.g. scenario analysis involves modelling the possible alternative paths of a social or political environment and possibly diplomatic and war risks. Then it will be in a position to consider how to distribute assets between asset types (i. a financial institution might attempt to forecast several possible scenarios for the economy (e. For example. moderate growth. in the recent Iraq War. In most cases an ANN is an adaptive system that changes its structure based on external or internal information that flows through the network during the learning phase. GEO-POLITICAL APPLICATIONS In politics or geo-politics. It might consider sub-sets of each of the possibilities. FINANCIAL APPLICATIONS For example. using adverse scenarios. They are usually used to model complex relationships between inputs and outputs or to find patterns in data. However. is a mathematical model or computational model that is inspired by the structure and/or functional aspects of biological neural networks. stocks and cash) in each of those scenarios. these are essentially simple mathematical models defining a function or a distribution over X or both X and Y. Modern neural networks are non-linear statistical data modeling tools. in economics and finance. the institution can also calculate the scenario-weighted expected return (which figure will indicate the overall attractiveness of the financial environment). rapid growth. this possibility is usually disregarded by organizations using scenario analysis to develop a strategic plan since it has such overarching repercussions. asset allocation). usually called "neural network" (NN). but sometimes models also .e. It consists of an interconnected group of artificial neurons and processes information using a connectionist approach to computation.

In comparison to training in an actual aircraft. connection weights. training and education. REAL LIFE APPLICATIONS: The tasks to which artificial neural networks are applied tend to fall within the following broad categories: • • • • Function approximation. The act of simulating something generally entails representing certain key characteristics or behaviours of a selected physical or abstract system. including pattern and sequence recognition. Simulation is also used when the real system cannot be engaged. or regression analysis. including filtering. safety engineering. including time series prediction. The real system may not be engaged because it may not be accessible. simulation based training allows for the . Classification. or process. Computer numerical control OTHER METHODS • • • • Simulation Prediction market Probabilistic forecasting and Ensemble forecasting Reference class forecasting SIMULATION: Simulation is the imitation of some real thing.intimately associated with a particular learning algorithm or learning rule. including the modeling of natural systems or human systems in order to gain insight into their functioning. testing. blind source separation and compression. it may be dangerous or unacceptable to engage. or specifics of the architecture such as the number of neurons or their connectivity). fitness approximation and modeling. or it may simply not exist FLIGHT SIMULATION: Flight Simulation Training Devices (FSTD) are used to train pilots on the ground. state of affairs.Simulation is used in many contexts. Simulation can be used to show the eventual real effects of alternative conditions and courses of action. including directing manipulators. clustering.[1] Other contexts include simulation of technology for performance optimization. Data processing. A common use of the phrase ANN model really means the definition of a class of such functions (where members of the class are obtained by varying parameters. novelty detection and sequential decision making. Robotics.

temperature can take on a theoretically infinite number of possible values (events) from zero to infinity. while in a simulation. Prediction markets are thus structured as betting exchanges.[1] For example. or virtual markets) are speculative markets created for the purpose of making predictions.. The current market prices can then be interpreted as predictions of the probability of the event or the expected value of the parameter. while keeping the pilot and instructor in a relatively low-risk environment on the ground. PROBABILISTIC FORECASTING: Probabilistic forecasting is a technique for weather forecasting which relies on different methods to establish an event occurrence/magnitude probability. electrical system failures. event derivatives. EPS does not produce a full forecast probability distribution over all possible events. the instructor can immediately preposition the simulated aircraft to an ideal (or less than ideal) location from which to begin the next approach. hydraulic system failures. decision markets. Assets are created whose final cash value is tied to a particular event (e.The probability information is typically derived by using several numerical model runs. Evidence so far suggests that prediction markets are at least as accurate as other institutions predicting the same events with a similar pool of participants. Implausibly high or low temperatures would then have close to zero probability values. total sales next quarter). and even flight control failures can be simulated without risk to the pilots or an aircraft. For example.g. Instructors can also provide students with a higher concentration of training tasks in a given period of time than is usually possible in the aircraft. instrument failures.training of maneuvers or situations that may be impractical (or even dangerous) to perform in the aircraft. and it is possible to use purely statistical or hybrid statistical/numerical methods to do this. without any risk for the bookmaker. information markets. a statistical method would produce a distribution assigning a probability value to every possible temperature. as soon as one approach has been completed. . idea futures. conducting multiple instrument approaches in the actual aircraft may require significant time spent repositioning the aircraft. Both techniques try to predict events but information on the uncertainty of the prediction is only present in the probabilistic forecast. technique used in deterministic forecasting. This differs substantially from giving a definite information on the occurrence/magnitude (or not) of the same event. will the next US president be a Republican) or parameter (e. while those who buy high and sell low are punished for degrading the market prediction.. This technique is usually referred to as Ensemble forecasting by an EPS Ensemble Prediction System (EPS). For example. with slightly varying initial conditions. PREDICTION MARKET: Prediction markets (also known as predictive markets.People who buy low and sell high are rewarded for improving the market prediction.g.

EXAMPLES: Canada has been one of the first countries to broadcast their probabilistic forecast by giving chances of precipitation in percentages. distribution forecasts of rainfall amounts by purely statistical methods have been developed whose performance is competitive with hybrid EPS/statistical rainfall forecasts of daily rainfall amounts. recently.[5] . As an example of fully probabilistic forecasts.

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