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# 2/2/2016

Econ 132
Day 4

To detrend a variable
Regress variable against trend (which may be linear or non-linear) and
subtracting it out of the original observations. The residual is the
detrended variable
Differencing. Differencing will typically remove the trend.
Does not require estimating any parameters (parsimonious)
Allows trend component to change over time (not deterministic)

## Forecasting Model Evaluation

To deseasonalize a variable
Do seasonal differencing. Difference using a lag period that is
equivalent to one season (e.g. for quarterly data 4 lags, for monthly
data 12 lags, etc.)
Take running average of data (one-season equivalent time periods)

## To deseasonalize and detrend

Sequentially difference. First seasonally difference to remove the
seasonal component and then difference one or more times (using
regular difference operator) to remove the trend.

## How to evaluate the performance of a forecasting

technique for a particular time series?
How to choose between competing forecasting
models?
Should not be based on only on the fit of the
forecasting model to historical data (or data used to
come up with the model).

2/2/2016

## Average error or mean error

Usually evaluation is done using one-step-ahead forecast errors
(1)= 1
where 1 is forecast of yt made one period prior.

Suppose that there are n observations for which forecasts have been
What follows are some standard measures of forecast accuracy.

error
=

=1 | (1) |

=1 (1)

## Estimate of the expected value of forecast error.

Unbiased forecasts if mean error is zero.
Biased forecasts if mean error is appreciably different
from zero.

=

2
=1[ (1)]

## Measures variability in forecast errors

Can be interpreted as an estimator of the variance of the
The square root of the MSE is the standard deviation of
forecast errors

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## Relative forecast error or percent forecast

error
ME, MAD, and MSE are scale-dependent measures of forecast
accuracy.
Values expressed in terms of original units of measurement.
Difficult to interpret whether errors are small or large.
Not very useful for comparisons across different time series or across
different time periods.

1 =

100 =

100

values.

=1 (1)

=1 | (1) |

2/2/2016

## Choosing between competing models

Selecting model that fits historical data best may not result in
forecasting method that provides best forecasts of new data.
Overfitting

Too many parameters in the model because they improve the model fit.