Forecasting Demand – Extrapolation Methods

Anton J. Kleywegt, Ph.D.

School of Industrial and Systems Engineering
Review of Previous Lessons

• Judgmental forecasting methods are driven

mostly by the opinions of experts
• Judgmental forecasting methods are by far
the most widely used forecasting approach in
practice
• Judgmental forecasting methods almost
always perform poorly compared with data-
driven forecasting methods
• Judgmental forecasting methods perform
particularly poorly when forecasters as
overconfident, and do not take the outside
view into account
Learning Outcomes
• Become familiar with some popular extrapolation
methods of forecasting
Forecasting Methods
• Classification of forecasting methods according to Armstrong, J.S. Long-range
Forecasting, Second Edition, 1985
Extrapolation Forecasting Methods
• Suppose you have data
• It is important that
the data be ordered,
usually ordered in
time t = 1,2,…,T,
because as the name
indicates, these
methods extrapolate
to t = T+1,T+2,…
• You want to forecast
• Denote the forecasts by
• You do not have data on
any other variables that
can help to forecast
Extrapolation Forecasting Methods

• Method 1, Simple Average:

• Simple Average is a
weighted average in which Averaging Weights
all weights are equal to 1/T 0.12
0.1
0.08
Weights 0.06
0.04
0.02
0
1 2 3 4 5 6 7 8 9 10
Time
Extrapolation Forecasting Methods

• Method 2, Moving Average:

• m-period Moving Average

is a weighted average in Averaging Weights for T = 10, m = 5
which the most recent m 0.25

weights are equal to 1/m 0.2

and the other weights are Weights 0.15

equal to 0 0.1
0.05
0
1 2 3 4 5 6 7 8 9 10
Time
Extrapolation Forecasting Methods

• Method 3, Weighted Average:

Averaging Weights
0.25
0.2
Weights

0.15
0.1
0.05
0
1 2 3 4 5 6 7 8 9 10
Time
Extrapolation Forecasting Methods

• Method 4, Exponentially Weighted Average:

Averaging Weights for a = 0.6

0.5
0.4
Weights

0.3
0.2
0.1
0
1 2 3 4 5 6 7 8 9 10
Time
Extrapolation Forecasting Methods

• Method 4, Exponentially Weighted Average (continued):

• Let’s derive a simpler expression for the forecast
Extrapolation Forecasting Methods

• Method 4, Exponentially Weighted Average

• Let’s derive a simpler expression for the forecast (continued):
Extrapolation Forecasting Methods

• Method 4, Exponentially Weighted Average

• Let’s derive a simpler expression for the forecast (continued):
Extrapolation Forecasting Methods

• Method 4, Exponentially Weighted Average (continued):

• In general, we use the following simpler expression to
update forecasts:

• This is called the simple exponential smoothing formula

• Note that the forecast for period t+1 is simply a weighted
average of the forecast for period t and the observed value
for period t
• The process can be initialized with any reasonable value
Extrapolation Forecasting Methods

• Method 4, Simple Exponential Smoothing (continued):

• Simple exponential smoothing is reasonable if there are no
predictable patterns in the data
5.25
5.2
5.15
5.1
Data Values

5.05
5
4.95
4.9
4.85
0 2 4 6 8 10 12
Time
Extrapolation Forecasting Methods

• Method 4, Exponentially Weighted Average (continued):

• What if there are predictable patterns in the data?

5.2

5.15

5.1
Data Values

5.05

4.95

4.9

4.85
0 2 4 6 8 10 12
Time
Extrapolation Forecasting Methods

• Method 5, Double Exponential Smoothing (Holt’s Method):

• Used if there is a predictable trend in the data
Extrapolation Forecasting Methods

• Exponentially Weighted Average (continued):

• What if there are predictable patterns in the data?

5.2

5.15

5.1
Data Values

5.05

4.95

4.9

4.85
0 2 4 6 8 10 12
Time
Extrapolation Forecasting Methods

• Method 6, Triple Exponential Smoothing (Additive Winter’s Method):

• Used if there is a predictable trend and cycles in the data
• First determine the cycle length/period P
Summary
• All forecasting based on some type of extrapolation –
we assume that the universe’s behavior in the future
will not be too different from the past
• With extrapolation methods we mean data-driven
methods where we have a sequence of data about the
thing that we want to forecast, and no data about
other relevant variables
• It is essential that the data follows a natural
sequence (usually in time)
• Examples
• Simple average
• Moving Average
• Exponentially weighted average
(exponential smoothing)