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March 1970, Volume 65, Number329

ApplicationsSection

AlternativeForecastingTechniques

R. M. LEUTHOLD,

quantityvariations.Thisstudyconcernsforecastingdaily hogpricesand quantities

in selectedterminalmarketsin the U. S. by using various causal and noncausal

models.The purposeis to examinethe economicand mathematicalcharacteristics

of the timeseriesdata, and then comparethe developedmodelsin termsof their

forecastingability. The performanceof each model is evaluated using the Theil

coefficient.

1. INTRODUCTION

Large daily priceand quantityfluctuationscharacterizemany ofthe agricul-

tural commoditiessold throughterminalmarketsin the United States. Most

related research is confinedto investigationsof recurrentcommodityprice

cycles,trends,and patterns,whilerelativelyfewinvestigationstreat the prob-

lem ofshort-runor daily priceand quantityvariations.This researchvoid may

stem fromthe difficulties in obtainingand analyzingdaily time series data.

In this study we attemptto forecastdaily hog pricesand daily quantitiesof

hogs suppliedby means of several alternativeforecastingtechniques.Our pur-

pose is to examinethe economicand mathematicalcharacteristicsof the time

seriesdata, then comparethe developed models as to theirforecastingability.

The hog industrywas chosen because (a) the daily fluctuationsin price and

quantity of hogs typifymany of the agriculturalcommoditiessold through

terminalmarkets,(b) hog productionand processingis a multimilliondollar

industryin the United States, and (c) data are available on daily hog prices

and quantitiessupplied foreach of the marketsstudied. To restrictour anal-

ysis, we forecastdaily hog prices in the eight largest United States terminal

hog markets,whichnot onlyrepresentthe major concentrationpointsofbuyers

and sellers but also act as a guide in the pricingof hogs in other markets

[9, 11]. The marketsselected foranalysis are Chicago, Indianapolis, Kansas

City,Omaha, South St. Joseph,East St. Louis, South St. Paul, and Sioux City.

However,in makingdaily quantitysuppliedforecasts,we aggregatethe above

and view them as a singlemarket.

To forecastdaily hog pricesand quantities,we employboth an econometric

model and recentdevelopmentsby Box and Jenkinsin time series modeling

[1, 2].1 The main distinctionis that the econometricmodel attemptsto identify

* R. M. Leutholdis assistantprofessorof agriculturaleconomics,Universityof Illinois.A. J. A. MacCormick

is researchassistant,Departmentof Statistics,Universityof Wisconsin,Madison. A. Schmitzis assistantprofessor

of agriculturaleconomies,assistantagriculturaleconomistin the ExperimentStationand is on the GianniniFoun-

dation,Universityof California,Berkeley.D. G. Watts is associateprofessorofstatistics,Universityof Wisconsin,

Madison. A large part of thii study was financedby the Economic Research Serviceof the U. S. Departmentof

Agricultureand the Universityof Wisconsin.The econometricmodel used is essentiallythat in 181.

1 The originaldraftof 121was issuedin 1966and 1967as TechnicalReportsNos. 72, 77, 79, 94, 95, 99, 103, 104,

116, 121,and 122 of the Departmentof Statistics,Universityof Wisconsin,Madison; and simultaneously as Tech-

90

DailyHog Pricesand Quantities

Forecasting 91

and measure both economic and noneconomicvariables affectingprice and

quantity,while the time series approach identifiesstochastic componentsin

each timeseries; that is, autoregressiveand moving average components.For

both approaches,1964 data on daily priceand quantityare used forestimation.

It has become conventionalto classifyforecastsas being eitherex post or

ex ante. In the latter,truevalues of exogenousvariables are not knownat the

timethe forecastis made, hence theymustbe estimated.Observedforecasting

errorsmay, therefore,be due to errorsin the estimatesof the predetermined

variables or incorrectspecificationof the model. In this study, the forecasts

presentedare of an ex post nature. These use the actual values of the prede-

terminedvariables to predictvalues forthe endogenousvariables; any errors

are, therefore,attributableonly to the model itself.

To test the predictiveaccuracy of the forecastsobtained by both the econo-

metric model and the parametric modeling approach, 1965 data are used.

Therefore,the models are testedusing data beyond the period of fit.Also, the

predictiveaccuracy of the differentforecastingapproaches is compared by

using Theil's inequalitycoefficient[13].

The coefficient used is:

2;(X - X,_1) 2

observation.It can be seen that U representsa comparisonofthesum ofsquares

of the one-step-aheadforecasterrorsof a model with those of a randomwalk

model. Thus fora randomwalk model, U = 1 always.

2. THE ECONOMETRIC

MODEL

The econometricmodel, which we estimate by ordinaryleast squares, is

composedof both a demand and a supply equation forlive hogs. The quantity

demandedis a deriveddemand as hogs are the major raw materialin producing

pork. Assumingprofitmaximization,the quantity of an input demanded de-

pends upon its price,the price of otherinputs,and output price. However, at

the major markets the supply of hogs generallyarrives beforethe markets

open,and the marketsare thenclearedeach day. The daily quantitydemanded

by the buyerson any particularday is predeterminedby the quantity avail-

able, and price is the adjusting mechanism.2Therefore,the demand function

expressesinput price as a functionof quantity,output price,plus othervari-

ables, such as storage and day of the week.

For the priceof output,we assume that Pt*= Pt-, wherePt* is the price at

time t which the packer expects to receivefor wholesale pork cuts afterpro-

cessing;and Pt-, is the actual price receivedthe previousday. As the previous

Lancaster,England.

2 Of course,quantityvaries fromday to day and fromweek to week. However,tradingat the terminalhog

marketsi8 conductedin such a fashionthat sellershave virtuallyno chance to respondto the pricewithinthe day.

This tradingcharacteristicis not necessarilytrueforcountrybuyers,dealers,and auctionmarkets,but theyare not

analyzedin thisstudy.

92 Journalof the AmericanStatisticalAssociation,March 1970

day's wholesale price increases,packer price bids for slaughterhogs will in-

crease the next day because of the expectationof higherwholesalepricesin the

future.

It is also hypothesizedthat the price packers offerforhogs depends in part

upon the numberof hogs they have on hand and the amount of pork in cold

storage. Eleven models were tested using various combinations of lagged

terminaland interiormarket quantities to find a proxy to representthese

storageitems.3The most appropriateproxyis the aggregatequantitysupplied

by the eight terminalmarketsforeach of the previous two days. Thus these

two quantitiesare includedin the demand functionto representstorage.

Additionalfactorscause packers to vary theirprice bids on hogs according

to the day of the week. One is the packers' attemptto filla specificnumberof

hours per week in theirlabor contract,requiringthem to increasetheirprice

bids at the beginningof the week so that theycan purchaselarge quantitiesof

hogs and be assured of fulfilling the contractsand maintaininga uniformrate

of slaughterthroughoutthe week. This and otherinfluencesare representedby

dummyvariables whichshiftthe demand functionaccordingto the day of the

week.4

The supply functionforslaughterhogs is derived fromthe classical theory

of the firm.Hog producersare assumed to operatein a purelycompetitivemar-

ket and attemptto maximizeprofits.One shortcomingof the theory,however,

is that it fails to distinguishbetweenmarketing(short-run)decisionsand pro-

duction(long-run)decisions.Since our concernis withthe short-run, the classi-

cal theoryis modifiedsomewhat to exclude past productioncosts and most

otherlong-runinfluences.

The quantity of hogs supplied at the eight terminalmarketsarrivesbefore

the marketsopen and thereis virtuallyno opportunityforproducersto adjust

their shipmentsin response to price withinthe day at these same markets.

Therefore,it is assumed that producersoperate on the basis of an expected

pricefortheirhogs,whichis based on informationgeneratedpriorto the mar-

ketingday. Eleven modelsusing various weightedand simple movingaverage

schemes of past prices to representthis expectationwere tested. The model

whichfitsthe data the best is one in whichthe expectedpriceis the same as the

previous market day's price, afteradjusting for the day of the week. Thus,

price lagged one period is included as an explanatoryvariable in the supply

function,withthe expectationthat as this priceincreases,producermarketing

responseswill increasethe next day and conversely.

Previous studies have shown the day of the week to be an importantinflu-

ence on quantity supplied [4, 12]. Farmers tend to marketmore hogs at the

beginningof the week, especially Monday, because they expect higherprices

then, and they have more time on weekends to prepare their livestock for

market.This phenomenonis representedby dummyvariables whichshiftthe

supply functionaccordingto the day of the week.

Hog farrowingfollowsseasonal patternsand this subsequentlyaffectsthe

numberofhogsto be marketedat latertimesafterthe necessaryfeedingperiod.

3 Daily data, specifically

suppliedare used as approximationsof storage.

4 These and othervariables whichgo to make up the demand model used are definedmorespecifically later.

Forecasting

DailyHog Pricesand Quantities 93

A variable whichshiftsthe supply functionaccordingto this seasonal adjust-

mentis includedas an explanatoryvariable.

The demand and supplyfunctionsas specifiedabove definea recursivemodel

of the cobweb type where firstthe quantity supplied is determinedthrough

the supply function,and then this quantity is sold in the market at a price

determinedthroughthe demand function.That is, the quantity demanded is

a predetermined variable and the errortermsof the demand and supplyfunc-

tions are assumed to be independent.Thus, with the normal assumptionson

stochastic regressors,ordinaryleast-squares regressionwill yield consistent

and asymptoticallyunbiased estimatorsof the parametersof each function.

The double (natural) logarithmicfunctionalformis used for both the de-

mand and supplyfunctionsbased on the assumptionthat buyersand producers

respond to percentage (or relative) changes in the market. Because of the

interestin explainingdaily changes ratherthan absolute amounts, plus the

need to reduce autocorrelationin the residuals and multicollinearityin the

originalvalues, the economic data are transformedinto firstdifferencesof

logarithms.However, the dummy variables are not transformedinto first

differencesand theyare specifiedto act as shiftersof the functions.The entire

statisticalmodel can be representedas follows:

Demand: A logPt = /11AlogWht-1 + 312AlogQt + f13AlogQe-1

+ 314AlogQt-2 + 115 logM + 116logT

+ j17 logW + f18log F + Aui(t)

Supply: A logQt = j321AlogPt-1 + f22 logM + /23 logT

+ 324logW + I25log F +f26 logS + Au2(t)

where

Pt= average price in dollars per hundredweight

of all barrows and

gilts sold at the eightmarketsin day t

Pt-, = representationforexpectedpriceby producers,definedthe same

as Pt but forthe previousday

Qt= total number of head of barrows and gilts sold at the eight

markets

Qt-s, Qt-2 = "proxy?'representations forstorage,definedthe same as Qt but

indicatingquantityon previousdays

Wht-,= representation of the priceof the output,measuredas a weighted

average (based on a percentof total live animal weight) of the

prices in dollars per hundredweightof major wholesale pork

cuts, Chicago

{=2.71828ifMonday

M 1.0000 otherwise

{:2.71828

ifTuesday

{:

T= 1.0000 otherwise

=2.71828ifWednesday

W 1.0000 otherwise

94 of theAmerican

Journal March1970

Association,

Statistical

F =2.71828ifFriday

= 1.0000 otherwise5

S = 2.71828ifMarch,

April,

August, October,

September, November

= 1.0000 otherwise

t= time in days

A = first differences,such that A log Qt= log Qt-log Qt-i, and

A log Qi-1= log Qt_l-log Qt2, etc.

Demandand SupplyEstimates

The above model was estimated,each equation separately,by ordinaryleast

squares regressionusing daily 1964 data for the aggregated eight markets.6

These resultsare presentedin Table 1. Estimates were also obtained foreach

of the eight marketsindividuallywith the only model alternationbeing the

inclusionof a weightvariable and a proxyforinformationflowsin the demand

equation. These resultsare not shown because (a) the size and statisticalsig-

nificanceof the coefficientsforthe individualmarketsare verysimilarto those

illustratedin Table 1 and technicallyadd nothingnew, and (b) our primary

interestis to see how well this basic model forecastsrelativeto the parametric

modelingapproach presentedlater.Also, because of thisinterestin forecasting,

the coefficients in Table 1 are not specificallyinterpretedfor their economic

implicationsexceptto note that the signsof the coefficients are consistentwith

the theoreticalframework ofthe model,that the coefficients are approximations

of elasticitiesor percentageresponses,and that the dummyvariables act as

demand and supply equation shifters.

Priceand Quantity

Forecasts

Using the precedingestimations,price and quantity forecastscan now be

determined.Predictionsof priceand quantityare made one successiveday at a

time for 1965 (data not used in estimation). The procedureis to insert the

knownvalues of the independentvariables into the proper functionand ob-

tain an estimate of the dependentvariable. This estimate is then compared

with the observedvalue of the dependentvariable forthat particularday.

For 1965 thereare nearly250 observationsforwhichprice and quantityare

predicted,and these resultsare summarizedby computingthe Theil coefficient

whichwas outlinedearlier.These coefficients,indicatingthe forecastingability

of the econometricmodel, are discussed later when we compare and evaluate

the alternativeapproaches to forecasting.

3. STOCHASTICNONCAUSALMODELS FOR PRICE

AND QUANTITYFORECASTING

Given past daily hog pricesand quantities,the problemis to forecastthese

for1, 2, 3, * * *, n days in thefuture.The approachused is timeseriesmodeling

5Dummy variablescannotbe specifiedforall fivedays of the weekas thiscreatesa linearcombinationin the

columnsof the raw momentmatrixand makesthe matrixsingular,so Thursdayis chosenas a base. The terminal

marketsare not open on Saturdayor Sunday.

6 Essentially,onlythe quantityvariableswereaggregated;the pricesforthe eightmarketswereaveraged.

Forecasting

DailyHog Pricesand Quantities 95

Table7. RESULTSOF DEMANDAND SUPPLYEQUATION

ESTIMATIONSUSING DAILYAGGREGATED DATA,1964

Independent and

Coefficient Independent and

Coefficient

variable standarderror" variable standarderror5

term (.0014) term (.0252)

A log Qg - .0542b A log Pt-I 8.2771b

(.0035) (.8409)

A log Qt-s - .0417b log M 3.5647b

(.0040) (.3326)

A log Qg2 - .0155b log T -1.2155b

(.0036) (.3276)

A log Wht-, .3536b log W -1.2955b

(.0471) (.3255)

log M .1609b log F _3.1978b

(.0218) (.3291)

log T .0768b log S .5219?

(.0242) (.2096)

log W - .0199 R2 .7147

(.0246)

log F - .0804b d (Durbin-Watson) 2.3516

(.0196)

R2 .5487

d (Durbin-Watson) 1.5990

a Figuresin parenthesesdenotestandarderror.

b Significant

at the 99 percentlevel of confidence.

c Significant

at the 95 percentlevel of confidence.

d Significant

at the 90 percentlevel of confidence.

NOTE: Dependentvariable (demand): A log Pt.

Dependentvariable (supply): A log Qt.

stochasticmodel whichdescribesthat series.

TimeSeriesModels

For the purposesof this article,two generaltimeseriesmodels are discussed

-stationary and nonstationary.An economic time series is stationaryif its

propertiesare unaffectedby a shiftin the timeorigin.In particular,a stationary

seriesvaries about some fixedmean u.

Models for StationaryTime Series. We denote the values of a series at

equally spaced times t, t-1, t-2, *- , by Pt, Pt-1, Pt-2, * . - . Let Xt, xti1,

Xt-2,***,be a "whitenoise" seriesconsistingof uncorrelatedrandomnormal

deviates,each with zero mean and variance ox..

96 Journalof the AmericanStatisticalAssociation,March 1970

Let ft = Pt- u, whereAtis thedeviationfromthe mean u. If this deviationis

linearlydependenton xi and on one or moreof the previousx's, thenwe have a

movingaverage (ma) model. For example,the firstorderma model is

Pt = Xt Oixt-1.(i

Pt = Xt - Gixt-i- O*Xt-q.

- (2)

xj, we have an autoregressive (ar) model. Thus,

Pt Xt + lPt-i (3)

is a firstorderar model. In general,a pth orderar model is

Pt = xt + q lPt-i + * * * + qPpt-P. (4)

In the above equations,Oqand op representthe parametersof the model which

are to be estimated.

Certaineconomictime seriesmay combineboth of the above models. Thus,

a generalmixed (ar-ma) model of order (p, q) can be writtenas

Pt - - **- pt-P = Xt - *-i * -OqXt-q. (5)

tionis definedby

BiPt = Pt-j. (6)

Op(B)Pt = 0q(B)xt (7)

that is, in Equation 5

op (B) = (I1- 0B- 02B2- * * BP_

O,(B) = (1 - 01B- 02B2- o

OqBq).

the mean. If, instead, the Pt's themselvesare used, the general formof the

modelrepresentedby Equation 5 may be writtenas

Op(B)Pt =o + Oq(B)xt (8)

where

G0= (1-41-02- * p*-&,)U.

[2], the models (2), (4), (5) and (8) may be used to representstationarytime

series.If the roots do not satisfythe stabilityconditions,the models may be

used to representcertainnonstationarytime seriesas describedbelow.

ModelsforNonstationaryTime Series [3, 6, 7, 14]. A simpletype of nonsta-

tionaryseries is one which is homogeneouslynonstationaryin level; that is,

ForecastingDaily Hog Pricesand Quantities 97

apart froma verticaltranslation,one part ofthe serieslooks muchlike another.

Such a serieshas the propertythat its firstdifference,

APt = Pt - Pt-, = (1 -B)Pt,

is a stationarytimeseries.The operatorA is called the difference

operator,and

its operationcan be definedby Ad= (1- B)d. A serieswhichhas neithera fixed

level nor a fixedslope but is otherwisehomogeneoushas the propertythat its

second difference, definedby

A'Pt = Pt- 2Pt_j + Pt2 = (1 -B)2Pt

is a stationarytime series.

Finally, to incorporatenonstationarityinto the previous models, let Yt be

the variable whose behavior we wish to represent.It is assumed that its dth

differenceAdYt=Pt can be representedby the stationary model given in

Equation 8. Since Ad= (1 -B)d, the model for Yt becomes

p(B) (I1- B)dYt = 0o + Gq(B)xt. (9)

Time Series Modeling.It is assumed that there exists a model of the form

Equation 9 which describesthe random propertiesof the available historical

data-hog pricesat Kansas City,forexample.The problemis to findvalues for

p, d, q and estimatesforthe parameterscp and Es such that the model "fits"

the data as closely as possible. Once a model has been satisfactorilyfittedto

the historicaldata, it may be used forforecastingfutureevents.

Every autoregressivetime serieshas an autocorrelationfunction(acf) which

is characterizedby an exponentialdecay, and it is possible by examinationof

the acfto identifythe order-that is, the value ofp-for an unknownar series.

Every ma time series,on the otherhand, has an acf whichhas only q non-zero

values. Afterlag q, all autocorrelationcoefficientsare zero. Inspection of the

sample acf computedfroma data seriesreveals *-+ to an experiencedobserver

whetherthe time series fromwhich it was computed is ar or ma or mixed

ar-ma and also the ordersp and q of the ar and ma components.

The sample autocorrelationcoefficient rk at lag k is computedfroma data

series P1, P2, * * , P. as follows:

Ck(P)

rk(P) =CkP

Ce (P)

where

1 n-k

Ck(P) (Pt - P)(Pt+k -5)

n t=l

and

ln

P= E P,

n t=i

is to obtain estimatesforthe parameters,cp,

i=l, . . ., p; and OA,i-1, . ., q. A brief outline of one method for doing

thisis given in the appendix.

98 Journal

of theAmerican

Statistical March1970

Association,

OF HOG PRICESAT KANSASCITY,MISSOURI

Figure7. AUTOCORRELATION

1.0

data

Original

0.5

V Firstdifference

0.0

2 4 6 8 10 12 14 16

Lag

-0.5

The thirdstep in fittinga model is to check that the model providesan ade-

quate fit,and this is done by examiningthe residuals.The residualsof a well-

fittedmodel will be very similarto white noise. In otherwords,if the fitted

model describesthe structureof the data sequence, therewill be no structure

leftin the residuals.We therefore examinethe aefof the residualsto detectany

structurewhich remainsand to findout how to alter our model to provide a

betterfit.

Example 1 (Price). The acf's computedfromthe originaldata and fromthe

firstdifference of the originaldata are plottedin Figure 1 fordaily hog prices

at Kansas City. The behavior exhibitedby the firstacf is characteristicof

nonstationarity-that is, it indicates that differencing is necessary. On the

otherhand, the acf of the firstdifference is approximatelyzero except at lag

zero. This behavior is characteristicof the acf of white noise. Therefore,the

implicationis that the operationof takingthe firstdifference of daily hog price

data at Kansas City produceswhitenoise. Thus the model

(1 - B)Pt = xt (10)

or

Ptnn Pt-1 + Xi

Forecasting

DailyHog Pricesand Quantities 99

Figure2. AUTOCORRELATION

OF TOTALHOG MARKETINGS

1.0

0.5

0.0

2 4 6 8 10 12 14 16

Lag

-0.5

representsthe behavior of hog price data at this market.7It was found that

the same behaviorapproximatelycharacterizesdaily hog pricedata at Chicago,

Indianapolis, Omaha, St. Joseph,St. Louis, St. Paul, and Sioux City.

The significanceof Equation 10 can be seen when it is used to forecasta

futurevalue. The estimatemade at time t (today) fora futureevent occurring

at time t+1 (tomorrow)is denoted by Pt+j and is obtained by takingthe ex-

pectation at time t+1 conditional on the informationavailable at time t.

That is,

Pt+1 = E(Pt+1) = E(Pt + Xt+l) = E(Pt) + E(xt+i).

But Pt is knownsince it is today's price,and E(xt+1) is zero since xt denotes

whitenoise with zero mean. Thus,

Pt+j = Pt. (11)

That is, the best estimateof tomorrow'sprice is today's price.

It is perhapsworthnotingthat this resultis not a defectin the model or the

model-fitting procedure,nor is it a defectwhichmay be rectifiedby more ad-

vanced noncausal models developed in the subsequent section. The result is

7 The process,model (10), sometimescalled a randomwalk model,was also foundto characterizestockmarket

prices.See [5, 10].

100 Journal

of theAmerican

Statistical

Association,

March1970

Figure3. AUTOCORRELATION

FUNCTIONOF FIRSTDIFFERENCE

OF TOTALHOG DELIVERIES

1.0

0.5

0.0

-0.5 2 A 6 8 10 12 14 16

Lag -

inherentin the data and tells us that the historicaldata alone do not contain

information which will enable us to forecastfuturepricesmore accurately.

Example 2 (Quantity).In Example 1 it is shownthat daily hog pricesforma

sequence whichfollowsa veryloose structure.Daily hog quantitysupplied,on

the other hand, has a quite definitestructure.For this example we use the

aggregateddaily hog deliveriesto the eightmarketsstudied. The autocorrela-

tionof the total quantityof hogs supplied is plottedin Figure 2. Inspectionof

theacfreveals (a) a strongfive-dayweeklyeffectand (b) possiblenonstationar-

ity over days or over weeks or over both. To investigate(b), one-day or five-

day differencing may be called for.

Figures 3 and 4 show the acf of the first Pt= (1-B)yt and weekly

P (1-B5)yt difference,respectively.Inspection of Figure 3 suggests the

following:

a. The high peaks at lag = 5, 10, 15, * indicate a weekly firstorder ar

component.

b. The peaks are of almostequal heightand so the weeklyar parameterwill

be quite large, probablyclose to 1.

c. The peaks are depressed-that is, a line drawnthroughthe peaks at lags

15, 10, and 5 would be nearly horizontaland would not intersectthe

verticalaxis close to 1.0. This suggeststhe presenceof a weeldyfirstorder

ma component.

DailyHog Pricesand Quantities

Forecasting 101

OF TOTAL

OF FIFTHDIFFERENCE

Figure4. AUTOCORRELATION

HOG DELIVERIES

1.0

0.5

0.0

2 4 V 6 8 10 12 14 16

Lag -

-0.5

e. The large magnitudeof the acf at lag= 1 suggeststhat firstdifferencing

is too stronga conditionto impose on the model.

In summary,Figure 3 suggeststhe model

(1 - VIB5)kv(B)Yt (1 -eB5)0q(B)xt (12)

where+Vis close to 1.0, and the structureof 4,(B) and Oq(B) is not yet clear.

Inspectionof Figure 4 suggeststhe following:

a. The deep troughat lag= 5 confirmsthe existenceof the weeklyfirstorder

ma component(1- EB5)in Equation 12.

b. The oscillatorynatureof the acfapart fromthe troughat lag= 5 suggests

a second orderar componentwithinweeks.

c. The oscillationsare quite small in amplitude and this may suggest the

presenceof a second orderma componentwithinweeks interactingwith

a second orderar componentwithinweeks.

In summary,Figures 3 and 4 suggestthe model

(1 -AtB5)(1 - -1B-02B2)Yt = (1 - eB5)(1 - 01B- 02B2)xt. (13)

In the actual fittingprocess no differencing

parametersbeingleftto findtheirown level. Several simplermodelsweretried,

and also a more complexmodel was triedin orderto check that the assumed

102 of theAmerican

Journal Statistical March1970

Association,

FUNCTIONOF RESIDUALSFROM FINALMODEL

Figure5. AUTOCORRELATION

0.3

0.2

0.1

0.0

-0.1

2 4 6 8 10 12 14 16

-0.2 Log -

above model displayed an acf closer to that of white noise, and a sum of

squares smallerthan all alternativemodels. The finalparametervalues are

6= .90 ki= 1.44 Oi = 1.52

e= .70 42 =-0.47 02= --0.66

(1 - O.90B5) (1 - 1.44B + 0.47B2) Yt = (1 - 0.70B5)

(1 - 1.52B + 0.66B2)xt.

4. PRICEAND QUANTITYFORECASTS:

A COMPARISONOF FORECASTING METHODS

Case 1 (Price)

As shown previously,the best noncausal forecastof daily prices is yester-

day's price; that is, PAt=Pt-j.That is not to say, however,that this random

walk model forforecastingpricesis the best possible. This is demonstratedin

Table 2 in whichthe Theil coefficientis calculated fromforecastson daily 1965

Forecasting

DailyHog Pricesand Quantities 103

Table2. PRICEFORECASTSEVALUATED FOR THEAVERAGEOF EIGHT

TERMINAL HOG MARKETS AND THREEINDIVIDUALMARKETS

(KANSASCITY,ST. PAUL,AND OMAHA),1965

Theil coefficient

Type ofmodel

AAverage

of Kansas City St. Paul Omaha

eightmarkets

Econometricmodel

Full model .7978 .7655 .8556 .8234

Economic variables .8888 .7806 .9599 .8255

Dummyvariables 1.0288 1.0329 .9847 1.0400

Random walk model 1.0000 1.0000 1.0000 1.0000

Mean model 18.2342 14.8747 14.6248 15.8638

price data for the average price of the eight markets and three individual

markets,8Kansas City, Omaha, and St. Paul, for (a) the econometricmodel

presentedat the outset, (b) the randomwalk model,and (c) a mean model. In

order to observe the influenceof the dummy variables, coefficientsfor the

econometricmodel are calculated for the full model (Table 1), the economic

variables alone, and the dummyvariables alone. (New regressionswere run in

each of the latter two cases.) The mean model simply uses the mean ofthe

data ti, . .. , tnto forecasttn+l

The Theil coefficients in Table 2 suggestthat the fulleconometricmodel does

a betterjob offorecastingdaily marketpricesthan does eitherthe randomwalk

or mean models in each of the fourcases presented.However, the differences

betweenthe Theil coefficients forthe econometricand randomwalk modelsare

extremelysmall when comparedwiththose forthe mean model. This suggests

that ifone chose to forecastpricesnoncausally,a randomwalk model would be

superiorto a simplemean model. Also, the coefficients indicate that using the

economicvariables alone will providemoreaccurate forecaststhan the random

walk model, while the dummy variables alone provide slightlyless accurate

forecasts,except for St. Paul. In each case the coefficient for the full econo-

metricmodel is smallerthan the respectivecoefficientwhen using economic

variables only,suggestingthe inclusionof the dummyvariables does provide

some increasein forecastingaccuracy.

Case 2 (Quantity)

The supply equation previouslyestimatedusing time seriesanalysis is

(1 - 0.90B5)(1 - 1.44B + 0.47B2)Yt = (1 - 0.70B5)(1 - 1.52B + 0.66B2)xt.

(1 - 1.44B + 0.47B 2- 0.90B5 + (0.90 X 1.44)B6 -(0.90 X 0.47)B7) Yt

= (1 - 1.52B + 0.66B2 - 0.70B5 + (0.70 X 1.52)B6 - (0.70 X 0.66)B7)xt.

Then, the forecastingequation is

2 Theother

fiveindividual arenotincluded

markets to thethreeshown.

aresimilar

as theirresults

104 of theAmerican

Journal Statistical March1970

Association,

Yt = 1.44Yt1- 0.47 Ye-2 + 0.90 Yt5 - (0.90 X 1.44)Ye-e

+ (0.90 X 0.47)Yt-7 + Xt - 1.52xt-,+ 0.66xt-2-0.70xt-5

+ (0.70 X 1.52)xt-6- (0.70 X 0.66)xt.-7

Thus, the one-step-aheadforecastis

Yt+1 1.44 Y - 0.47 Yt-1 + 0.90 Y-4 - (0.90 X 1.44) Yt_5

+ (0.90 X 0.47) Yt-6 + E(xt+1)- 1.52xt+ 0.66xt_-- 0.70xt-4

+ (0.70 X 1.52)xts5- (0.70 X 0.66)xt-6

where Yt, ** , Yt-6 and xt, * * *, xt-6 have already been observed,but xt

has not. Since x representszero-meanwhite noise, E(xt+) =0.9

Table3. SUPPLYFORECASTSEVALUATED

FOR THE TOTALQUANTITY

SUPPLIEDOF EIGHTTERMINAL

HOG MARKETS,1965

Econometricmodel

Full model .65

Economicvariables .95

Dummy variables .75

Random walk model 1.00

Mean model .96

Time seriesmodel .70

Table 3 gives the Theil coefficients for the above time series forecasting

model and three other models-(1) the econometricmodel presentedat the

outset and then divided into two subgroupsin the same fashionas described

whenforecastingdaily prices,(2) a randomwalk model,and (3) a mean model.

The latter two were also discussedin the previoussection. In contrastto the

mean model forprices,the mean modelforsupplydoes a betterjob offorecast-

ing than does the randomwalk model. However, neitherof these can forecast

as well as the fulleconometricor timeseriesmodels. Comparingthe lattertwo,

the fulleconometricmodel does a betterjob of forecastingas the Theil coeffi-

cientis .70 forthe timeseriesmodel and .65 forthe econometricmodel. On the

otherhand, the timeseriesmodel is moreaccurate than the econometricmodel

if eitherthe dummyor economicvariables are used alone. Using the dummy

variables alone (.75) is more accurate than using the economicvariable alone

(.95). This latter relationshipmightbe expected when consideringthe strong

weeklyeffectdemonstratedby the time seriesmodel.

5. CONCLUSION

This study is concernedwith forecastingdaily hog prices and quantities in

selectedterminalmarketsin the United States. Forecasts are made usingvari-

9For example,the three.step-aheadforecastis

Y9+3 = 1.44 Y,+2 - 0.47 Yt+? + 0.90 Yt2 - (0.90X1.44) Yg.3

+ (0.90X0.47) Y_4 + 0.66 E(xt+i) - 0.70 Xti-

+ (0.70 X 1.52) xt-3- (0.70X0.66) xtg_

whereE (xt+l) -0.

DailyHog Pricesand Quantities

Forecasting 105

ous causal and noncausal models,includinglinear stochasticmodels. The per-

formanceof each model is evaluated using the Theil coefficient.

The findingssuggestthat daily hog prices exhibita randomwalk behavior;

similarfindingswere previouslydiscovered with daily stock market prices.

However,our resultsindicate that this does not necessarilymean that a ran-

dom walk modelprovidesthe best forecastofprices.As shown,our econometric

model yields more refinedprice forecasts,even when only the economicvari-

ables are used and the dummyvariables are excluded. When the dummyvari-

ables are used alone, generallythe resultsare less accurate than the random

walk model. Our resultsalso suggestthat in forecastingdaily quantities the

econometricmodel yields slightlysuperiorresultsthan the time series model.

However,the time seriesmodel is more accurate than if the dummyvariables

are used alone in the econometricmodel.

It should be emphasized that the Theil coefficient for comparingforecasts

does not take into account the costs involved in constructingalternativefore-

castingmodels. One advantage of timeseriesmodelingis that only data on the

variable to be forecast are needed. However, in constructingeconometric

models,data are needed on both the regressandand regressors.Therefore,even

thoughthe forecastsusingthe econometricmodel are slightlybetterthan those

using a stochasticnoncausal framework,the cost of makinga slightlygreater

errorusing the latter could well be less than the additional cost involved in

settingup an econometricmodel and collectingthe data. Unfortunately, we do

not have these cost figures.

APPENDIX

The stochasticmodels and the methods for fittingthem describedin this

articleare due to the workof Box and Jenkins[2]. The fittingof a model is an

iterativeprocess which consistsof three steps: identification,estimation,and

diagnosticchecking.

It is conventionalforstatisticalproblemsto begin with an assumed model

but, in practice,a sequence of observationsdoes not come with a label tied to

it indicatingwhich model to assume. Thus, "identification"is the procedure

for obtainingan approximateand intuitiveidea of the structurewhich may

reasonablybe assumed to describethe observedbehavioruntilfurtherevidence

is obtained indicatinghow the model may be modifiedto provide a closer fit

to the data. We have brieflyillustratedthe identification of a model fora lag

quantitymarketeddata sequence.

Autoregressiveparametersin the model may easily be estimatedby least

squares, but moving average parameterscause difficulty. There are several

ways to overcome this difficulty

[21. We used a gridsearch method as follows:

Suppose we have identifieda model of the form

Pt - -lPt-1 2Pt-2 = Xt - GlXt-1 - O2Xt-2 (1)

We want to estimate 41, k2, 01, and 02. We know that they must fall withina

stabilityregion[2] and, by refinement procedure,we have a

of theidentification

roughguess as to values forthe estimatesOl,62.We select an area containing

the coordinatesof our guess and imagine a grid superimposedupon it. Each

106 Journalof the AmericanStatisticalAssociation,March 1970

grid point representsa possible value for 6i and 62. For each grid point we

computeresidualsfromthe ma part of the model. Symbolically,we write

(1 - -1B 2B2)Pt (1 - 01B- 02B2)xt

= (1 - 01B- 02B2)et (3)

where

et = (1 - 01B - 4)2B2)-1xt (4)

and we computethe residuals

et-Pt + 02et- + 62e.-2. 2 (5)

Now, usingleast squares, we computeestimates '), 42 and residualsxtand the

sum of squared residuals Ett2 from

(1 - 1B -2B2))t = t.

estedin minimizingthe residualsum of squares, and so we take the gridpoint

at whichthe smallest sum of squares occurs to give estimates6', 02. Starting

values foret,in Equation 5 may presenta minorproblem (see [2] fordiscus-

sion); but since our data sequence contains 257 data points, the errorintro-

duced by settinginitialvalues equal to zero is considerednegligible.

How good is our assumed model? Diagnostic checkingseeks to findout. If

theassumed model is satisfactory,it describesall the structurein the data se-

quence and the residualswill consistof whitenoise. Thus, diagnosticchecking

consistsofapplyingthe identification phase ofour investigationto the residuals

ofthe assumed model. It is to be hoped that identification will show that the

residualsdo consistof whitenoise; but ifnot, a model will be identifiedforthe

residualsaild this will be incorporatedas a modificationto the originalmodel,

parameterswill be reestimated,residualswill be rechecked,and so on until a

satisfactoryfitis obtained.

REFERENCES

[1] Box, G. E. P., and Jenkins,G. M., "Some Recent Advances in Forecastingand

Control,"Applied Statistics,17, No. 2 (1968).

[21 --, Time SeriesAnalysisForecasting and Control,"(In preparationforpublication

by Holden-Day, San Francisco).

[31Brown,R. G., Smoothing, Forecasting, and PredictionofDiscreteTime Series,Engfle-

wood Cliffs,N. J.: Prentice-Hall,Inc., 1962.

[4] Cramer,Charles, WhytheEarly-WeekMarket?NorthCentral Regional Publication

91, MissouriArgicultural ExperimentStationBulletin712, Columbia,1958.

[5] Granger,C. W., "Some AspectsoftheRandom Walk Model ofStock MarketPrices,"

InternationalEconomicReview,9, No. 2 (June1968).

[61Holt, C. C., ForecastingTrendsand Seasonals by ExponentiallyWeightedMoving

Averages,Carnegie Instituteof Technology,O.N.R. MemorandumNo. 52, Pitts-

burgh,1957.

17] -,Modigliani, F., Muth,J. F., and Simon, H. A., Planning Production,Inven-

tories,and WorkForce,EnglewoodCliffs,N. J.: Prentice-Hall,Inc., 1960.

DailyHog Pricesand Quantities

Forecasting 107

[81 Leuthold,Raymond M., "An EconomicAnalysisof Daily Hog Price Fluctuations,"

UnipublishedPh.D. dissertation,Universityof Wisconsin,Madison, 1968.

[9] Love, Harold G. and Shuffett,D. Milton,"Short-RunPrice Effectsof a Structural

Change in a Terminal Market for Hogs," Journalof Farm Economics,47, No. 3

(August 1965).

[101 Mandelbrot,Benoit, "Some Aspects of the Random Walk Model of Stock Market

Prices:Commnent," EconomicReview,9, No. 2 (June1968).

International

[111 National Commissionon Food Marketing,Food FromFarmerto Consumer, Washing-

ton: U.S. GovernmentPrintingOffice,June 1966.

(121 Schneidau, R. E., Pherson,V. W., and Cox, C. B., Is Therea Best MarketDay?

Pardue UniversityArgiculturalExperimentStation, Research Bulletin 709, La-

fayette,1960.

[13] Theil, Henri,AppliedEconomicForecasting, Amsterdam:North-HollandPublishing

Co., 1966.

[141 Winters,P. R., "ForecastingSales by ExponentiallyWeightedMoving Averages,"

ManagementScience,6, No. 3 (April1960).

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