Adaptive Forecasting

Prof. Suresh K Jakhar

Indian Institute of Management Lucknow
 Introduction:
 The estimates of level, trend, and seasonality
are updated after each demand observation.
 The main advantage of this technique is that
estimates incorporate all new data that are
observed.
Adaptive Forecasting

Ft 1  ( Lt  Tt ) St 1
Where
Lt = estimate of level at the end of Period t
Tt = estimate of trend at the end of Period t
St+1 = estimate of seasonal factor for Period t+1
Ft+1 = forecast of demand for Period t+q (made
Period t or earlier)
Dt+1 = actual demand observed in Period t
Et+1 = Ft+1 – Dt+1 = forecast error in Period t
 Steps in Adaptive Forecasting

 Initialize
◦ Compute initial estimates of level (L0), trend (T0), and
seasonal factors (S1,…,Sp)
 Forecast
◦ Given the estimates in Period t, forecast demand for period
t+1
 Estimate error
◦ Compute error Et+1 = Ft+1 – Dt+1
 Modify estimates
◦ Modify the estimates of level (Lt+1), trend (Tt+1), and
seasonal factor (St+p+1), given the error Et+1
 Methods
1) Moving Average
2) Simple Exponential Smoothing
3) Trend-Corrected Exponential Smoothing
(Holt’s Model)
4) Trend- and Seasonality-Corrected Exponential
Smoothing (Winter’s Model)
 Moving Average

 Used when demand has no observable trend or

seasonality
Systematic component of demand = level
 The level in period t is the average demand over the
last N periods
Lt = (Dt + Dt-1 + … + Dt–N+1) / N
Ft+1 = Lt and Ft+n = Lt
 After observing the demand for period t + 1, revise
the estimates
Lt+1 = (Dt+1 + Dt + … + Dt-N+2) / N, Ft+2 = Lt+1
 Moving Average Example

 A supermarket has experienced weekly demand of

milk of D1 = 120, D2 = 127, D3 = 114, and
D4 = 122 gallons over the past four weeks

◦ Forecast demand for Period 5 using a four-period

moving average
◦ What is the forecast error if demand in Period 5 turns
out to be 125 gallons?
Moving Average Example
L4 = (D4 + D3 + D2 + D1)/4
= (122 + 114 + 127 + 120)/4 = 120.75

 Forecast demand for Period 5

F5 = L4 = 120.75 gallons

 Error if demand in Period 5 = 125 gallons

E5 = F5 – D5 = 120.75 – 125 = – 4.25

• Revised demand
L5 = (D5 + D4 + D3 + D2)/4
= (125 + 122 + 114 + 127)/4 = 122
 Simple Exponential Smoothing

 Used when demand has no observable trend

or seasonality
Systematic component of demand = level
 Initial estimate of level, L0, assumed to be
the average of all historical data
Simple Exponential Smoothing

1 n
Given data for Periods 1 to n L0 = å Di
n i=1

Current forecast Ft+1 = Lt and Ft+n = Lt

Revised forecast using

smoothing constant Lt+1 = a Dt+1 + (1– a )Lt
(0 < α < 1)
Simple Exponential Smoothing
 Supermarket data
4
L0 = å Di / 4 = 120.75
i=1

F1 = L0 = 120.75

E1 = F1 – D1 = 120.75 –120 = 0.75

L1 = a D1 + (1– a )L0
= 0.1´120 + 0.9 ´120.75 = 120.68
Likewise…
 Trend-Corrected Exponential Smoothing
(Holt’s Model)

 Appropriate when the demand is assumed to

have a level and trend in the systematic
component of demand but no seasonality

Systematic component of demand =

level + trend
 Trend-Corrected Exponential Smoothing
(Holt’s Model)

 Obtain initial estimate of level and trend by

running a linear regression
Dt = L0 + t T0
 In Period t, the forecast for next period is
Ft+1 = Lt + Tt
Revised estimates for Period t+1
Lt+1 = αDt+1 + (1 – α)(Lt + Tt)
Tt+1 = β(Lt+1 – Lt) + (1 – β)Tt
 Example:Holt’s Model
 An electronics manufacturer has seen demand
for its latest MP3 player increase over the
past six months. Observed demand (in
thousands) has been D1 = 8,415; D2 = 8,732;
D3 = 9,014; D4 = 9,808; D5 = 10,413; and D6
= 11,961. Forecast demand for Period 7 using
trend-corrected exponential smoothing with α
= 0.1, β = 0.2.
 Trend-Corrected Exponential Smoothing
(Holt’s Model)

 MP3 player demand

D1 = 8,415, D2 = 8,732, D3 = 9,014, D4 = 9,808,
D5 = 10,413, D6 = 11,961, α = 0.1, β = 0.2
 Using regression analysis
L0 = 7,367 and T0 = 673
 Forecast for Period 1
F1 = L0 + T0 = 7,367 + 673 = 8,040
 Period 1 error
E1 = F1 – D1 = 8,040 – 8,415 = –375
 Trend-Corrected Exponential Smoothing
(Holt’s Model)
 Revised estimate
L1 = αD1 + (1 – α)(L0 + T0)
= 0.1 x 8,415 + 0.9 x 8,040 = 8,078
T1 = β(L1 – L0) + (1 – β)T0
= 0.2 x (8,078 – 7,367) + 0.8 x 673 =
681
 With new L1
F2 = L1 + T1 = 8,078 + 681 = 8,759
 Continuing
F7 = L6 + T6 = 11,399 + 673 = 12,072
 Trend- and Seasonality-Corrected
Exponential Smoothing

 Appropriate when the systematic component

of demand has a level, trend, and seasonal
factor
Systematic component = (level + trend) x
seasonal factor

Ft+1 = (Lt + Tt)St+1

 Trend- and Seasonality-Corrected
Exponential Smoothing

 After observing demand for period t + 1, revise

estimates for level, trend, and seasonal factors
Lt+1 = α(Dt+1/St+1) + (1 – α)(Lt + Tt)
Tt+1 = β(Lt+1 – Lt) + (1 – β)Tt
St+p+1 = γ(Dt+1/Lt+1) + (1 – γ)St+1
α = smoothing constant for level
β = smoothing constant for trend
γ = smoothing constant for seasonal factor
Example: Winter’s Model
L0 = 18,439 T0 = 524
S1= 0.47, S2 = 0.68, S3 = 1.17, S4 = 1.67
F1 = (L0 + T0)S1 = (18,439 + 524)(0.47) = 8,913
The observed demand for Period 1 = D1 = 8,000
Forecast error for Period 1
= E1 = F1 – D1
= 8,913 – 8,000 = 913
 Winter’s Model

 Assume α = 0.1, β = 0.2, γ = 0.1; revise estimates for

level and trend for period 1 and for seasonal factor
for Period 5
L1 = α(D1/S1) + (1 – α)(L0 + T0)
= 0.1 x (8,000/0.47) + 0.9 x (18,439 + 524) = 18,769
T1 = β(L1 – L0) + (1 – β)T0
= 0.2 x (18,769 – 18,439) + 0.8 x 524 = 485
S5 = γ(D1/L1) + (1 – γ)S1
= 0.1 x (8,000/18,769) + 0.9 x 0.47 = 0.47
F2 = (L1 + T1)S2 = (18,769 + 485)0.68 = 13,093
Time Series Models

Forecasting Method Applicability

Moving average No trend or seasonality
Simple exponential No trend or seasonality
smoothing
Holt’s model Trend but no seasonality

Winter’s model Trend and seasonality