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6.1

Seasonality & Forecasting

Overview of Seasonality

Seasonality (dfn): Any cyclical or periodic ﬂuctuation in a time-series that recurs or repeats itself at the same phase of the cycle or period. Examples: • Toy sales at Christmas • Ice cream sales in the summer • Peruvian anchovy production Seasonality has implications for temporal aggregation of the data. Example: • Toy Sales at Christmas Data is to be collected . . . Quarterly — Every 4th quarter Monthly — Every 12th month Weekly — Every 52n d week Yearly — ???

6.2

Seasonality & The ARIMA Model

The basic thrust of the ARIMA perspective, with regard to seasonality, is to identify (and model) the problem rather than assume that it either does or does not exist. ARIMA models provide an improvement over past eﬀorts to “deseasonalize” the time-series through the use of dummy variables. The latter approach simply employs multiple regression with dummy variables to estimate the seasonal variance of each phase of the cycle. This estimated variance is then subtracted from the time-series. This approach, however, is inadequate (see McCleary & Hay, p.81) 6.2.1 Parallel Concepts

Seasonal Non-Stationarity (dfn): Trend or drift in steps rather than as “observation to observation steps.

0. yt = yt−12 + θ0 Seasonal AR (dfn): Partial dependence on some steps back in the series. 1. D. . yt = φ12 yt−12 + at The (seasonal) autocorrelation could depend. d. 1. on corresponding observations from 2 preceding cycles. to some extent. s = 12 for monthly data s = 4 for quarterly data s = 52 for weekly data Example: (1. (1 − φ12 B 12 )yt = at or. 1)(0.Example: (1 − B 12 )yt = θ0 or. q)(P. . 0)(1. ARIMA(0. where s is the seasonality. so that. 1)12 . Q)s . 0. 0)12 (1 − θ1 B)(1 − θ12 B 12 )yt (1 − θ1 B − θ12 B 12 + θ1 θ12 B 13 )yt yt − θ1 yt−1 − θ12 yt−12 + θ1 θ12 yt−13 θ1 yt−1 + θ12 yt−12 − θ1 θ12 yt−13 + at = = = = at at at yt The approach can be extended to model a time-series that drifts or trends regularly & seasonally. written as: (1 − φ12 B 12 − φ24 B 24 )yt = at Seasonal MA (dfn): Partial persistence from shocks back in the cycle. such as . yt = (1 − θ12 B 12 )at = at − θ1 2at−12 It is also possible to combine seasonality with other components of a time-series: ARIMA(p.

• ARIMA(0. then just “match up .Note that the order of diﬀerencing in practice does not matter because: (1 − B)(1 − B 12 ) = (1 − B 12 )(1 − B) = (1 − B − B 12 + B 13 ) Therefore. −1 < θ. d. as before — know how the diﬀerent models behave. ACF (s) ≈ ACF (2s) ≈ ACF (3s) ≈ · · · ≈ ACF (ks) Seasonal diﬀerencing (0. 0)(P. Q)s can be written as an inﬁnite series of exponentially weighted past observations. 6. the diﬀerencing can occur simultaneously: ∗ zt = (1 − B)(1 − B 12 )yt = (1 − B − B 12 + B 13 )yt = yt − yt−1 − yt−12 + yt−13 Finally. 0)s will make the ACF stationary. . 0. you can diﬀerence regularly: ∗ zt = yt − yt−1 and then diﬀerence seasonally: zt ∗ = zt − zt−12 or vice-versa. 0.2 φs < 1 θs < 1 Identiﬁcation The same logic applies here. with the same result. D. in theory. 0)s models can be written as an inﬁnite series of exponentially weighted past shocks. • Invertibility conditions −1 < φ. . D.2. • ARIMA(p. q)(0. . Or. ” Example: Seasonal Non-stationarity Large and nearly equal values of the ACF at all seasonal lags.

with the rate of decay determined by.2 Deﬁnitions Forecasting: The likelihood of future events given current & past information. φP s The PACF has P spikes at the ﬁrst P seasonal lags (with all other successive lags expected to be zero).15) 6. Interval Forecast: Prediction of the interval in which a number will lie. · · · . Figures 15. · · · . why has there been so little use of ARIMA methods in the area of forecasting? 6. θ2s . θ3s . an entire cottage industry has sprung up around the issue of forecasting. φ3s . The PACF will decay from seasonal lag to seasonal lag. pp.3. 0. θs . Q)s will have Q spikes at the Q seasonal lags of the ACF (with the rest being zero).1 Forecasting Background Somewhat surprisingly. so you can evaluate accuracy exactly. 0)s has a decaying ACF. if you can ﬁnd it at all [Clear up from M&H. Ex Ante Forecast: A prediction beyond the estimated period using explanatory variables with and without certainty. McCleary & Hay contend that small order will work. 457-9.• ARIMA(0. However. θQs • ARIMA(P.3 6. there appears to be a presumption that forecasting is not an important topic for most of the social sciences (including political science) — the notable exception being Economics. Ex Post Forecast: Knowing all values of the exogenous and endogenous variables with certainty. φ2s . A more interesting question is.3. pp.14 & 15. 87-9] Example: Hog Production (see Pindyck & Rubinfeld. Point Forecast: Prediction of a single number. with the rate of decay determined by. φs . 0. .

yti is the forecast from time t. s(t).2.T1 T2 T 3 (present) time (t) . s(t) = a0 + a1 X1 (t − 3) + a2 X2 (t − 4) + t If this equation is estimated. the results can be used to produce an unconditional forecast of s(t) 1. we would use the current value of X1 & last month’s value of X2 . both of which are known. - Estimation Period Ex Post Forecast Period Ex Ante Forecast Period Unconditional Forecast: All explanatory variables are known with certainty. To get the 3 month forecast of s(t). 6. 6. but with lags of 3 & 4 months respectively then.3. out i steps. Conditional Forecast: Forecasts themselves are used to predict values. so that forecasts must be used to produces the forecast on the dependent variable. Example: If monthly sales.3 Criteria for Determining Optimum Forecast Mean Square Forecast Error (MFSE) M F SE = 1 n n (yt+i − yti )2 i=1 (1) where. are linearly related to 2 variables. Values for one or more explanatory variables are unknown. X1 & X2 . and 3 months into the future.3.4 ARIMA Forecasting Pindyck & Rubin present a general development for the general model: φ(B)∆d yt = θ(B) t (2) .

yt = (1 + φ1 B + φ2 B 2 + · · · + φn B n + · · ·)at 1 1 = at + φ1 at−1 + φ2 at−2 + · · · + φn at−n + · · · 1 1 Taking expectations yields. . (1 − B)−1 = 1 + B + B 2 + · · · + B k + · · · So that. ⇒ yt = yt + θ0 Then. Unconditional Forecast for AR(1) (1 − φ1 B)yt = at yt = (1 − φ1 B) at Recall. As l becomes large. the mean is the best prediction. −1 (3) . . E[yt ] = E[yt ] + θ0 = 0 + θ0 = θ0 (Mean) “Extrapolating” yields: yt (1) = E[yt+1 ] = 0 . . E[yt ] = E[at ] + φ1 E[at−1 ] + φ2 E[at−2 ] + · · · + φn E[at−n ] + · · · 1 1 = 0 + φ1 · 0 + φ2 · 0 + · · · + φn · 0 + · · · 1 1 = 0 Since yt = yt − θ0 .McCleary & Hay (Chapter 4) have a much simpler treatment. yt (n) = E[yt+n ] = 0 This implies that an unconditional forecast will always have the same value . This is not surprising since the series is stationary. . the series mean.

yt (n) = φn yt 1 To construct conﬁdence intervals it is necessary to write the model in terms of an inﬁnite sum of shocks (i. conditional forecasts are given by: yt (1) = E[at+1 ] + φ1 yt = φ1 yt yt (2) = φ2 yt 1 . . in terms of φ weights). Then interval forecasts can be calculated for these weights. For yt+1 we have: yt+1 = at+1 + ψ1 at + ψ2 at−1 + · · · + ψk at−k+1 + · · · Taking expectations yields: E[yt+1 ] = E[at+1 ] + ψ1 at + ψ2 at−1 + · · · + ψk at−k+1 + · · · = 0 + ψ1 at + ψ2 at−1 + · · · + ψk at−k+1 + · · · = ψ1 at + ψ2 at−1 + · · · + ψk at−k+1 + · · · (6) (5) (4) . .Conditional Forecast for AR(1) — will depend on previous forecasts Consider a one-step ahead expression for an AR(1) model: yt+1 = φ1 yt + at+1 (1 − φ1 B)yt+1 = at+1 yt+1 = (1 − φ1 B)−1 at+1 = (1 + φ1 B + φ2 B 2 + · · ·)at+1 1 = at+1 + φ1 at + φ2 at−1 + · · · 1 Taking expectations yields: E[yt+1 ] = E[at+1 ] + φ1 at + φ2 at−1 + · · · + φn at−n 1 1 = E[at+1 ] + φ1 yt = 0 + φ1 yt = φ1 yt Thus. yt = at + φ1 at−1 + φ2 at−2 + · · · + φk at−k + · · · Example: ARIMA Model with 4th Order Seasonal Lag (1 − φ1 B)(1 − φ4 B 4 )yt = at yt = (1 − φ1 B)−1 (1 − φ4 B 4 )−1 at = (1 + φ1 B + φ2 B 2 + · · ·)(1 + φ4 B 4 + φ2 B 8 + · · ·)at 1 4 = at + φ1 at−1 + · · · + (φ4 + φ4 )at−4 + (φ5 + φ1 φ4 )at−5 + · · · 1 1 The φ’s can be considered weights (ψ).e.

Therefore. 6. it can be shown that: 2 2 V ar(2) = (1 + ψ1 )σa 2 If φ1 = 0.5 Forecast Proﬁles McCleary & Hay and Pindyck & Rubinfeld both develop “proﬁles” for diﬃcult ARIMA models.96 V ar(2) < yt (2) < 1. than V ar(1).96 V ar(1) < yt (1) < 1.96 V ar(1) Similarly. Assuming that all the ψ weights & past shocks are known. V ar(2) will have a larger error component. They show that the nature of the point forecasts and conﬁdence intervals are not all the same. (1 + ψ1 ). Therefore.96 V ar(2) Moreover. They vary with respect to: • Conditional forecasts • Interval forecasts due to diﬀerent ψ weights .E[at+1 ] = 0 is employed here because the value of the future random shock (at+1 ) is unknown. (9) So. −1. we can use the conditional expectation as a forecast of yt+1 . the Error in Forecasting is given by: et+1 = yt+1 − E[yt+1 ] = yt+1 − yt (1) = at+1 The Forecast Variance is given by: 2 V ar(1) = E[e2 ] = σa t+1 (7) (8) Which is the variance of the white noise process. the interval forecast of yt+1 is given by: −1.3. 2 2 2 2 V ar(n) = (1 + ψ1 + ψ2 + · · · + ψn−1 )σa V ar(n) will be even larger if uncertainty exists — resulting from a poor ﬁt of coeﬃcient estimates.

the variance around these point estimate forecasts is constant for all lead times.2(c) (p.2 (p.0) — Random Walk McCleary & Hay. Forecasts tend to increase with increases in lead time (with the conﬁdence intervals increasing at a rate determined by φ1 ). yt (n) equals the process mean. yt (n) = E[at+n ] = 0 Because the ψ weights are zero.0) — White Noise (which is: yt = at ) There are uniformly zero weights: ψ1 = ψ2 = ψ3 = · · · = ψk = 0 The point forecasts are: yt (1) = E[at+1 ] = 0 yt (2) = E[at+2 ] = 0 . 2.1.216) After only two or three steps into the future the conﬁdence intervals become so large as to make the interval forecasts meaningless. 2 V ar(n) = σa For this proﬁle. the forecasts regress to the process mean and conﬁdence intervals at each point.0. ARIMA(2. 4.2(a) (p.0. ARIMA(0. the history of the process results in no improvement to the prediction. ARIMA(0. .0. V ar(n) remains constant.0) — Autoregressive McCleary & Hay. . Moreover. Figure 4. Figure 4.1. 2 V ar(1) = σa 2 V ar(2) = σa . 3. Therefore.217) As the lead time increases. Figure 4. The best forecast is the process mean.219) Pindyck & Rubinfeld. .1) — Moving Average McCleary & Hay. . . ARIMA(0.2(b) (p. Figure 18. the conditional and unconditional expectations are identical.524) For lead times > 1.

– There are some interesting implications for this approach in quality control. If the last observation is an extreme value its presence can be problematic. Also. Figure 18. . This is because M A(q) processes have a memory of only q periods. Applications: Political Forecasting Literature (e. for most ARIMA models the last observation often has the most impact.0) — Mixed (Autoregressive-Moving Average) Pindyck & Rubinfeld.4 Summary & Discussion • McCleary & Hay suggests using these models to forecast 2-3 periods ahead. ARIMA(1.529) Examples: (Pindyck & Rubinfeld) • Interest Rates • Hog Production 6. they are quick to point out that there is nothing you can do in a social system if this is what you have and there is a need for longer forecasts. Only the most recent observations have much impact on the AR forecast since exponential weights and invertibility will wipe out the eﬀect of long memory (seasonality is something of an exception here). Actual data can be used only if l < q. – Not many people appear to use forecasting models in this manner. . However.6 (p. • McCleary & Hay see more value in forecasting as a diagnostic tool.5.g.5 & 18. Peterson) Next Week . at most. Intervention Analysis .1. because of their potential unreliability. • Both McCleary & Hay and Pindyck & Rubinfeld stress the short-run value of ARIMA models for forecasting purposes.

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