Chapter 9:

Forecasting

Emin Ilyas
 Chapter Objectives
▪Discuss the importance of forecasting and identify the most appropriate type of
forecasting approach, given different forecasting situations.
▪Apply a variety of time series forecasting models, including moving average,
exponential smoothing, and linear regression models.
▪Develop causal forecasting models using linear regression and multiple regression.
▪ Calculate measures of forecasting accuracy and interpret the results.
Forecasting
▪ Forecast – An estimate of the future level of
some variable.
▪ Why Forecast?
▪ Assess long-term capacity needs
▪ Develop budgets, hiring plans, etc.
▪ Plan production or order materials
Types of Forecasts
▪ Demand
▪ Firm-level
▪ Market-level
▪ Supply
▪ Number of current producers and suppliers
▪ Projected aggregate supply levels
▪ Technological and political trends
▪ Price
▪ Cost of supplies and services
▪ Market price for firm’s product or service
Laws of Forecasting
▪ Forecasts are almost always wrong by some amount (but
they are still useful).
▪ Forecasts for the near term tend to be more accurate.
▪ Forecasts for groups of products or services tend to be
more accurate.
▪ Forecasts are no substitute for calculated values.
Forecasting Methods
▪ Qualitative forecasting techniques – Forecasting techniques
based on intuition or informed opinion.
▪ Used when data are scarce, not available, or irrelevant.

▪ Quantitative forecasting models – Forecasting models that

use measurable, historical data to generate forecasts.
▪ Time series and causal models
Selecting a Forecasting Method

Figure 9.2
Qualitative Forecasting Methods

▪ Market surveys
▪ Build-up forecasts
▪ Life-cycle analogy method
▪ Panel consensus forecasting
▪ Delphi method
Quantitative Forecasting
Methods
▪ Time series forecasting models – Models that use a series
of observations in chronological order to develop
forecasts.

▪ Causal forecasting models – Models in which forecasts

are modeled as a function of something other than time.
Demand movement
▪ Randomness – Unpredictable movement from one time
period to the next.

▪ Trend – Long-term movement up or down in a time

series.

▪ Seasonality – A repeated pattern of spikes or drops in a

time series associated with certain times of the year.
Time series with randomness

Figure 9.3
Time series with
Trend and Seasonality

Figure 9.4
Last Period Model
▪ Last Period Model - The simplest time series
model that uses demand for the current
period as a forecast for the next period.
=
Ft+1 Dt
where Ft+1= forecast for the next period, t+1
and Dt = demand for the current period, t
Last Period Model

Table 9.3 Figure 9.5

Moving Average Model
▪ Moving Average Model – A time series
forecasting model that derives a forecast by
taking an average of recent demand value.
Moving Average Model
Period Demand
1 12
2 15
3 11
4 9
5 10
6 8
7 14
3-period moving average
8 12
forecast for Period 8:

= (14 + 8 + 10) / 3
= 10.67
Weighted Moving Average
Model
▪ Weighted Moving Average Model – A form of
the moving average model that allows the
actual weights applied to past observations
to differ.
Weighted Moving Average
Model
Period Demand
1 12
2 15
3 11
4 9
5 10
6 8
7 14
8 12 3-period weighted moving
average forecast for Period 8=
[(0.5 × 14) + (0.3 × 8) + (0.2 × 10)] / 1 =
11.4
Exponential Smoothing Model
▪ Exponential Smoothing Model – A form of the
moving average model in which the forecast for the
next period is calculated as the weighted average of
the current period’s actual value and forecast.
 Exponential Smoothing Model
α = .3
Period Demand Forecast
1 50 40

2 46 .3 * 50 + (1-.3) * 40 = 43

3 52 .3 * 46 + (1-.3) * 43 = 43.9

4 48 .3 * 52 + (1-.3) * 43.9 = 46.33

5 47 .3 * 48 + (1-.3) * 46.33 = 46.83

6 .3 * 47 + (1-.3) * 46.83 = 46.88

Adjusted Exponential
Smoothing
▪ Adjusted Exponential Smoothing Model – An expanded version of the
exponential smoothing model that includes a trend adjustment factor.

AFt+1 = Ft+1 +Tt+1

where AFt+1 = adjusted forecast for the next period
Ft+1 = unadjusted forecast for the next period = α Dt + (1 – α) Ft
Tt+1 = trend factor for the next period = β (Ft+1 – Ft) + (1 – β)Tt
Tt = trend factor for the current period
β = smoothing constant for the trend adjustment factor
Linear Regression
▪
Linear Regression
▪ How to calculate the a and b
Linear Regression – Example
9.3
Linear Regression – Example
9.3
Linear Regression – Example
9.3

Figure 9.12

The graph shows an upward trend of 7.33 sales per month.

Seasonal Adjustments
▪ Seasonality – Repeated patterns or drops in a
time series associated with certain times of
the year.

Table 9.8
Seasonal Adjustments
▪ Four-step procedure:
▪ For each of the demand values in the time series, calculate the corresponding
forecast using the unadjusted forecast model.
▪ For each demand value, calculate (Demand/Forecast). If the ratio is less than
1, then the forecast model overforecasted; if it is greater than 1, then the
model underforecasted.
▪ If the time series covers multiple years, take the average (Demand/Forecast)
for corresponding months or quarters to derive the seasonal index. Otherwise
use (Demand/Forecast) calculated in Step 2 as the seasonal index.
▪ Multiply the unadjusted forecast by the seasonal index to get the seasonally
adjusted forecast value.
Seasonality – Example 9.4
Note that the regression
forecast does not reflect
the seasonality.

Figure 9.15
Seasonality – Example 9.4
Seasonality – Example 9.4
Calculate the (Demand/Forecast) for each of the time periods:
January 2012: (Demand/Forecast) = 51/106.9 = .477
January 2013: (Demand/Forecast) = 112/205.6 = .545

Calculate the monthly seasonal indices:

Monthly seasonal index, January = (.477 + .545)/2 = .511

Calculate the seasonally adjusted forecasts

Seasonally adjusted forecast = unadjusted forecast x seasonal index
January 2012: 106.9 x .511 = 54.63
January 2013: 205.6 x .511 = 105.06
Seasonality – Example 9.4

Note that the regression

forecast now does
reflect the seasonality.

Figure 9.16
Causal Forecasting Models
▪ Linear Regression
▪ Multiple Regression
▪ Examples:
Multiple Regression
▪ Multiple Regression – A generalized form of linear
regression that allows for more than one independent
variable.
Forecast Accuracy
How do we know:
▪ If a forecast model is “best”?
▪ If a forecast model is still working?
▪ What types of errors a particular forecasting model
is prone to make?
Need measures of forecast accuracy
Measures of Forecast Accuracy
▪ Forecast error for period (i) =

▪ Mean forecast error (MFE) =

▪ Mean absolute deviation (MAD) =

Measures of Forecast Accuracy
▪ Mean absolute percentage error (MAPE) =

▪ Tracking Signal =
 Forecast Accuracy – Example
9.7

Table 9.11
Forecast Accuracy – Example
9.7
▪ Calculate the forecast error for each week,
the absolute deviation of the forecast error,
and absolute percent errors.
Forecast Accuracy – Example
9.7
Forecast Accuracy – Example
9.7
▪ Model 2 has the lowest MFE so it is the least
biased.
▪ Model 2 also has the lowest MAD and MAPE
values so it appears to be superior.

▪ Calculate the tracking signal for the first 10

weeks.
Forecast Accuracy – Example
9.7
Forecast Accuracy – Example
9.7
▪ The tracking signal for Model 2 gets very low
in week 5, however the model recovers.

▪ You need to continue to update the tracking

signal in the future.