PREDICT INDONESIA COMPOSITE INDEX WITH INFLATION AND

EXCHANGE RATE (UDS/IDR) BY USING MACHINE LEARNING MODEL

ABIGAIL OLIVIA ANGELICA DAVIDSON

A thesis submitted in fulfilment of the

requirements for the award of the degree of
MASTER OF SCIENCE IN
DATA SCIENCE AND BUSINESS ANALYTICS

ASIA PACIFIC UNIVERSITY OF TECHNOLOGY & INNOVATION (APU)

2021
 ACKNOWLEDGEMENT

All praise and thanks are due to God Almighty for His favour in allowing the
"PREDICT INDONESIA COMPOSITE INDEX WITH INFLATION AND
EXCHANGE RATE (UDS/IDR) BY USING MACHINE LEARNING MODEL"
research to be accomplished. Because the author is aware of the research's flaws and
limits, he received help from a variety of sources to complete it. On this occasion, the
author would like to express his thanks to his supervisor, Dr. Ho Ming Kang; thank you
for constantly giving the author with direction, excitement, and fresh information so
that this research could be finished appropriately. In addition, I'd like to thank my
second marker, Dr. Dewi Octaviani, as well as my classmates for providing comments
and inspiration during this research.

i
 ABSTRACT

The COVID-19 epidemic has radically changed the global order. Not only is it a health
concern, but the virus's spread has slowed the global economy. The major goal of this
study is to develop, forecast, and propose a model that simultaneously explains
Inflation and Exchange Rate (USD/IDR) dynamics in the face of Indonesia Composite
Index during the COVID-19 pandemic. As a result, employing a time-series machine
learning model is the best way to discover the optimal model for accurately predicting
ICI. Monthly data for all variables from March 2019 to September 2021 will be used
in this study.

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 TABLE OF CONTENTS
ACKNOWLEDGEMENT ............................................................................................................. i
ABSTRACT ................................................................................................................................... ii
List of Tables ................................................................................................................................. iv
List of Figure .................................................................................................................................. v
CHAPTER 1................................................................................................................................... 1
1.1 Background ..................................................................................................................... 1
1.2 Problem Statement ......................................................................................................... 3
1.3 Research Question .......................................................................................................... 4
1.4 Research Aims and Objectives ...................................................................................... 5
1.5 Scope of Study ................................................................................................................. 5
1.6 Significance of the Study ................................................................................................ 5
1.7 Structure of the Report .................................................................................................. 6
CHAPTER 2................................................................................................................................... 7
2.1 Introduction ..................................................................................................................... 7
2.2 Inflation............................................................................................................................ 7
2.3 Exchange Rate ................................................................................................................. 8
2.4 Indonesia Composite Index ............................................................................................ 9
2.5 Related Research ............................................................................................................. 9
2.6 Summary........................................................................................................................ 13
CHAPTER 3................................................................................................................................. 15
3.1 Introduction ................................................................................................................... 15
3.2 Research Approach....................................................................................................... 15
3.2.1 Data Collection ....................................................................................................... 16
3.2.2 Description of Dataset ........................................................................................... 17
3.2.3 Data Preparation ................................................................................................... 17
3.2.4 Model Creation ...................................................................................................... 18
3.2.5 Model Assessment .................................................................................................. 20
3.3 Summary........................................................................................................................ 20
REFERENCE .............................................................................................................................. 21
Appendix A: Fast-Track Form................................................................................................... 25
Appendix B: Log Sheet ............................................................................................................... 29

iii
 List of Tables
Table 1. Related Works ............................................................................................... 10

iv
 List of Figure
Figure 1. Framework Research .................................................................................... 16

v
 CHAPTER 1

INTRODUCTION

1.1 Background
Coronavirus, also known as COVID-19, is an infectious disease caused by the Sars-
CoV-2 virus, which causes severe respiratory sickness. The disease was first
discovered in December 2019 in Wuhan, China, and has since spread around the world,
culminating in the COVID-19 pandemic. The World Health Organization (WHO)
named the COVID-19 outbreak a Public Health Emergency of International Concern
(PHEIC) on January 30, 2020, and a pandemic on March 11, 2020. In addition, the
COVID-19 pandemic has altered the world order drastically. Not only is it a health
issue, but the virus’s spread has also put the brakes on the global economy. Many
offices, factories, and retail malls have closed, transportation has essentially ceased to
operate, and many businesses have decreased their workforces (Supriatna, 2020).

Because Indonesia is the world's fourth most populous country, it is likely to be hit
harder and for a longer period than other, less populous countries. Indonesia reported
no instances of infection during the most severe epidemic of the novel coronavirus
SARS-CoV-2 in China, which lasted from December 2019 to February 2020. President
Joko Widodo proclaimed the first two confirmed instances of COVID-19 infection in
Indonesia on March 2, 2020. As of April 2, 1,790 confirmed cases, 113 new cases, 170
fatalities, and 112 recoveries have been reported across the nation. (Nurhayati, 2021).

According to the Indonesian Ministry of National Development Planning report 2020,

the COVID-19 epidemic created fear in global financial markets during the first quarter
of 2020. The Rupiah exchange rate depreciated dramatically because of this situation.
If the firm buys raw materials while the Rupiah value depreciates, the exchange rate
has an impact on profits. The circumstance causes the company’s earnings to drop, or
it may even result in a loss. The rupiah has been falling about 10.2% since February,

1
reaching about IDR16,000 by the end of March 2020. Externally, the Rupiah’s
devaluation was impacted by bad sentiment on global financial markets because of the
COVID-19 pandemic’s broad impact.

The Fed’s decision to lower the benchmark interest rate to 0 until 0.25% adds to the
growing sense of global unease and the risk of worldwide economic downturn. As a
result of this situation, the flow of global capital from poor nations to secure financial
assets and commodities has reversed (flight-to-safety). On the domestic front, the
Rupiah’s depreciation was driven by – relatively low economic growth in the first
quarter of 2020, which only reached 2.97%; decreasing growth in bank lending; the
current account deficit; and the balance of trade deficit (Kementerian PPN/Bappenas,
2020).

Inflation is a state in which prices continue to rise over an extended period. When
compared to the same period in 2019, the COVID-19 epidemic has also caused
inflation to rise. Annual inflation rates in the first quarter of 2020 were 2.68%, 2.98%,
and 2.96%, respectively (year on year). From January through March 2020, monthly
inflation rates were 0.39%, 0.28%, and 0.10%, respectively (month to month). In
addition, the Consumer Confidence Index (CCI) fell in the first quarter of 2020. The
CCI for each month from January to March 2020 was 121.70, 117.70, and 113.80,
indicating a decline in public purchasing power.

Investors are adjusting their financial portfolios by moving liquidity to haven assets,
such as Indonesia, due of the uncertainty surrounding the conclusion of the COVID-19
epidemic. The domestic capital market was put under strain because of these
circumstances, although overall capital market stability was preserved. The Indonesia
Composite Index (ICI) has dropped substantially, indicating that stock market
conditions have deteriorated dramatically. In the first quarter of 2020, ICI closed at
4,538.9, a drop of 29.8 percent (year on year). The value of the stock market
capitalization came under rather strong pressure in tandem with the movement of the

2
ICI. In the first quarter of 2020, the stock market capitalization was IDR5,247.6 trillion,
a decrease of 28.7% compared to the first quarter of 2019 (year on year).

However, since COVID-19 has become a hot topic, many researchers have tried to
predict stock prices using machine learning models. For example, despite considerable
market volatility at the initial peak of the COVID-19 pandemics, Bayesian Neural
Networks may give acceptable forecast (Chandra & He, 2021). Next, machine learning
algorithms must be proven to improve and identify hidden patterns in the data.
Therefore, a comparison between machine learning models is needed to decided the
best model for predicting stock prices. Navid & Sara (2021) found that the
Autoregression model proved to be more accurate when the market experiences high
volatility than Long Short-Term Memory and XGBoost.

1.2 Problem Statement

Stock price forecasting is essential to market players since a relatively correct
prediction may result in significant financial gains, as well as policymakers who study
the market effect of all occurrences. Successful prediction can provide investors with a
desirable reward, but numerous circumstances, such as pandemics and societal
movements, can substantially impact market pricing. The global spread of the COVID-
19 virus has enormous economic consequences. The impact of COVID-19 on the stock
market has been observed recently (Baker et al., 2020).

The COVID-19 epidemic shook the world in the first quarter of 2020, forcing
governments to curtail economic activity. As a result, all countries' economic
development has been stifled once more (BAPPENAS, 2009). In Indonesia, the capital
market, including the stock and bond markets, has been affected by the COVID-19
epidemic. The ICI value in March 2019 was IDR6,468,755 (a percentage of 0.39%)
and fell by -0.21% in April 2019 to IDR6,455,352 (a percentage of 0.39%). Until the
end of December 2019, the development of this ICI remained quite steady. Then,
towards the end of January 2020, ICI saw another large drop, with a final number of
IDR5,940,048 (Fusion Media, 2021).

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Furthermore, at the end of February 2020, the ICI value had dropped to 5,452,704 with
a percentage of -13.44%. The downward trend continued in mid-March 2020, with a
final total of 4,907,571 people or a -22.10% decrease. The Indonesia Composite Index
report from the Financial Services Authority backs up this claim. According to statistics
obtained from the official website of PT. Indonesia Stock Exchange (IDX), ICI fell
13.44% from January 1 to February 28, 2020 (year to date). Rupiah was “infected”
with the COVID-19 in addition to the ICI. The Rupiah has corrected to IDR14,413 per
USD, according to data from Bank Indonesia (BI) on the Jakarta Interbank Spot Dollar
Rate reference rate as of March 2, 2020. The Rupiah currency rate has fallen by 3.7%
from January 2, 2020, when it was at IDR13,895 per USD (IDX, 2020).

Meanwhile, according to the IDX Press Release on August 20, 2021, the ICI at the
close of trading was in the green one and remained at the psychological level of 6,000,
to be precise at the level of 6,030,772. Overall, during the week, the ICI experienced a
change of 1.77% from the position of 6,139,492 at the close of last week. Then, a
change of 1.90% occurred in the market capitalization value of the stock exchange
during the week to IDR7,267,791 trillion from IDR7,400,658 trillion in the previous
week. The Stock Exchange’s average daily transaction volume increased by 3.40% to
22,651 billion shares from 23,448 billion shares previous week. The exchange’s
average daily frequency increased by 7.34% to 1,458,268 transactions from 1,573,789
the previous week (IDX, 2021).

1.3 Research Question

This study intended to use a machine learning model to forecast ICI during COVID-
19, while fulfilling the following research question:
1. How did the inflation and exchange rate (USD/IDR) impact the ICI during the
COVID-19 pandemic?
2. What is the most suitable model to forecast the ICI?
3. How will the proposed prediction model be tested and evaluated?

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1.4 Research Aims and Objectives
This research aims to explore, create, forecast, and propose a model that significantly
explains inflation and exchange rate (USD/IDR) dynamic during the COVID-19
epidemic while accounting Indonesia Composite Index of companies listed on the
Indonesia Stock Exchange (IDX). This research will use time-series machine learning
model to obtain accurate results. The objective of this research are to:
1. Determine the influence of inflation and exchange rate (USD/IDR) on the ICI
during the COVID-19 pandemic.
2. Recommend the best model to predicting ICI during COVID-19 pandemic.
3. Evaluate the performance of the ICI’s proposed prediction model’s
performance.

1.5 Scope of Study

The Inflation variable, the Exchange Rate (USD/IDR), and the Indonesia Composite
Index are the only variables used in this study. The study is limited to businesses listed
on the Indonesia Stock Exchange (IDX) and Bank Indonesia provided the data for this
study from March 2019 until September 2021. Three models that will be used on this
research are: Vector Auto Regression (VAR), which is a statistical model that captures
the changing connection between several quantities over time; Long Short-Term
Memory (LSTM) is a neural network development that can be used for modelling and
able to overcome long-term dependencies on the output; and Autoregressive
Conditional Heteroskedasticity (ARCH) is the most volatile model for time series
forecasting, and is well-trained for identifying dynamic fluctuations in time series
volatility.

1.6 Significance of the Study

The government and economic actors will benefit from this research. If COVID-19
strikes again in the future, this study will attempt to estimate the impact of the pandemic
on inflation, currency exchange rates, and ICI. The machine learning model that will
be used is of course to predict accurately. This is so that the findings of this study can
be taken into consideration by the government in formulating early steps if COVID-19
or other pandemics strike Indonesia. So that the economy, especially the stock market

5
in Indonesia, remains stable. For economic actors and investors to be more careful in
investing and try to support and assist the government in always maintaining economic
stability.

1.7 Structure of the Report

There are six chapters in this Capstone Project that are organized to meet the goal of
this research, which is to present a model that explains inflation and exchange rate
developments in the face of ICI during the COVID-19 epidemic. The brief description
of each chapter as follows.

The basic idea of this study is provided in Chapter 1 Introduction by establishing the
domain in the context of the investigation. The problem statement is then stated,
followed by three research questions. Furthermore, the purpose of this study is stated
in the goals and objectives that are linked to the research question. Next, scope of a
study that describe the scope and limitations of this research. Finally, there’s
significance of the study, which is a written statement that explains why this research
was necessary.

Next, the second chapter provides a comprehensive overview of previous relevant

literature on this study issue. The sorts of prediction models, methodologies, and
datasets utilized in previous research studies for comparable purposes are scrutinized.
Last, the third chapter discusses research technique, with an emphasis on this study’s
research strategy. The dataset that was used in this investigation will be discussed, as
well as the data pre-processing method used. In this chapter, the machine learning
model that will be described and details on proposed the suitable model for this
research.

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 CHAPTER 2

LITERATURE REVIEW

2.1 Introduction
Shares are sign of ownership of individual or institutional investors over several funds
invested in a company (investment). The decline in stock prices is unavoidable due to
COVID-19, so investors must be careful in investing in conditions like this. In general,
stock exchanges around the world are also experiencing a decline (Ngwakwe, 2020).
Many businesses closed or went bankrupt, unemployment and poverty increased, and
fear struck many investors so that investors sold their shares to avoid significant losses.

Therefore, the prediction of ICI during this COVID-19 situation will help investors and
help the government stabilize the economic situation. In this chapter, an overview of
all variables in this research will be explained. Moreover, the work of previous
researchers will be analysed and evaluated to expand on their results and recognize
their problems and limits. To continue this research, the gaps in earlier efforts will be
acknowledged.

2.2 Inflation
Inflation is a continuous increase in the average price level or the process of increasing
the prices of goods as a whole and continuously. The high rate of inflation is usually
influenced by the unfavorable economic conditions of a country. The occurrence of
inflation causes several effects in economic activity, namely the effect on income,
efficiency, and output (Gumilang et al., 2014).

Rising inflation can reduce people’s purchasing power because the price of necessities
increases, while people’s income remains constant. So, that inflation is often a problem,
especially if the government is not successful or unable to control the rate of economic
growth. The inflation rate is the percentage increase in prices that differs from one

7
period to another and varies from country to country. Moderate inflation is inflation
that reaches between 4 until 10%.

Inflationary pressures are frequently linked to overheated economic situations. This

indicates that when the demand for a commodity exceeds the supply capacity of that
product, prices tend to rise. Inflation that is excessively high results in a loss in money's
buying power. If the rate of inflation falls, along with the purchasing power of money,
it will be a favourable indication for investors (Tandelilin, 2001).

2.3 Exchange Rate

The exchange rate or what is often referred to as the exchange rate is a certain amount
of currency that can be exchanged for other currencies (Purnasari et al., 2020). The
exchange rate of the rupiah against other currencies affects the profit of a company
because companies that use production materials from abroad will experience an
increase in the value of debt if the rupiah against foreign currencies decreases or
depreciates.

The exchange rate has a significant impact on firms looking to invest, since if the forex
market is more appealing than the capital market, investors would prefer to utilise it.
International pricing coordinates the actions of consumers and producers while dealing
in foreign marketplaces, and exchange rates play a significant role in coordinating
between buyers and sellers in these markets.

The government uses a variety of approaches to determine the exchange rate of foreign
currencies. These methods include:
1. Fixed Exchange Rate – a situation in which the government sets the local
currency exchange rate. In this case, the government uses a variety of
measures and regulations to keep the value of its currency stable at a certain
price. Price fluctuations will be soaked up by the government or through
intervention. If there is a surplus, the government will purchase it. If there
is a surplus of demand for a specific foreign currency, the government will
sell its supply. This system is indeed able to provide certainty about

8
 currency exchange rates, but the weakness is that the government must have
very large foreign exchange reserves to maintain the value of its currency.
2. Floating Exchange Rate – without government interference, the amount of
the exchange rate is left to the market process. The high and low points of
a currency are influenced by the currency's demand and supply.
3. Managed Floating Rate – the exchange rate can move freely up or down,
but the government will intervene to avoid fluctuations that are too sharp.
The government begins to intervene when the price reaches a certain
threshold, for example 5% above or below the equilibrium level. The
intervention can be in the form of dirty floating or direct intervention by
selling or buying foreign currency; or clean floating or indirect intervention
by setting interest rates.

2.4 Indonesia Composite Index

The Indonesia Composite Index is an indicator of the stock price index that describe a
fair stock market condition that occurred in the written period. In addition, the stock
price index is defining as the main indicator that describes stock movements. The stock
price changes are usually published every day, depending on the exchange’s closing
price on that day. The index is shown for a certain time.

New emissions, such as the addition of new issuers to the Stock Exchange, or corporate
activity in the form of splits, rights, warrants, stock dividends, bonus shares, and
convertible shares, all contribute to the rise in the number of outstanding shares.
Growth in the potential to create profits, rather than sales per unit, is the desired
outcome (Purnasari et al., 2020). The study of the link between stocks and currency
rates has far-reaching consequences for interpreting market behavior using data and
events from other markets (Immanuel, 2015).

2.5 Related Research

The results of several previous studies that have researched the same theme will be
used as reference and comparison materials in this study, which is shown on table
below:

9
 Table 1. Related Works

Related Author Dataset Data Mining Evaluation Prediction Research

Work Description Technique Metrix Outcome Limitation
Impact of Štifanić et Historical data The Wavelet Root Mean RMSE The data used
COVID-19 al., (2020) from West Transform Square 0.02116 does not have
on Texas and Error MAE many data
Forecasting Intermediate Bidirectional (RMSE) 0.01701 points such as
Stock Crude Oil and Long Short- and Mean long-time
Prices: An the Dow Jones Term Average historical
Integration Industrial Memory Error intraday data
of Stationary Average, S&P (MAE) to get a more
Wavelet 500, and precise
Transform NASDAQ forecast. In
and Composite addition, the
Bidirectiona stock indexes forecasting
l Long with the model used is
Short-Term number of also very
Memory COVID-19 limited so that
confirmed the robust
cases. system is also
limited.
Financial Sugiyanto The ICI Autoregressiv Smoothed The crisis This research
Crisis Model et al., monthly data e Moving Probability was is only to
in Indonesia (2020) and dollar Average – if the detected in detect the
Based on exchange rates (ARMA), value of July 1997 occurrence of
Indonesia to rupiah taken Autoregressiv smoothed to October a crisis in the
Composite from 1990 to e Conditional probability 2000, past and does
Index (ICI) 2017. Heteroscedast is less than March not propose a
and Dollar icity 0.4708, the 2001 to model to
(US) (ARCH), condition is September detect a crisis
Exchange SWARCH stable, but 2001, and in the future
Rates to Model if the value October
Rupiah of 2008 to
Indicators smoothed April 2009.
probability
is more

10
 than
0.4708, the
condition is
crisis.
Identificatio Ulrichs Polish Vector Auto Markov- VAR This study
n of (2018) quarterly data Regression Switching model can presents
Financial for the period Method Model explain the conclusions
and 1998-2016 interactions based on the
Macroecono between approximate
mic Shocks the real results of a
in A VAR economy, machine
Model of the learning model
The Polish financial for the Polish
Economy system and economy. So
monetary that it becomes
policy in very limited
Poland, because what
because is presented is
financial only an
and estimate
macroecon without any
omics further
shocks predictions.
were
identified
by the
impulse
reactions
function
that change
after the
financial
crisis.
Determinant Goh et al., Daily data of Multiple Adjusted R MLR – This study
s and (2021) Jakarta Stock Linear Squared Adjusted R only predicts
Prediction of Exchange Regression Squared the future short
the Stock (JKSE) (MLR) and 71.9%

11
 Market Composite An Algorithm FFT – term of the
during Index, Interest of Fourier Adjusted R stock price.
COVID-19 Rate, and Transformati Squared
Evidence Exchange Rate on (FFT 90.5%
from from 15 Model)
Indonesia October 2019
to 15
September
2020.
Data Budiharto Bank Central Long Short- RMSE RMSE This study
Science (2021) Asia and Bank Term 94.57% only predicts
Approach to Mandiri Stock Memory the future short
Stock Prices Price in 2020 (LSTM) term of the
Forecasting from Yahoo stock price.
in Indonesia Finance
during
COVID-18
using Long
Short-Term
Memory
Stock Price Mottaghi Daily stock Auto- MAE, Auto- The stock data
Forecasting & prices of regression, RMSE, and regression used are only
in Presence Farhangdo famous LSTM, Last Value is the best well-known
of COVID- ost (2021) companies that XGBoost suitable companies, so
19 Pandemic obtained from model the methods
and Yahoo Finance because the and models in
Evaluating form January value of this research
Performance 2015 to April MAE and cannot be used
of Machine 2021. RMSE is to predict the
Learning almost stocks of other
Models for same with companies.
Time-Series the Last
Forecasting. Value.
The Impact Shula Data is Regression Adjusted Adjusted R The project is
of GDP, (2017) collected from R Square Square limited to
Inflation, the Lusaka 97.5% economic
Interest, and Stock condition in

12
 Exchange Exchange Zambia and
Rates GDP Index from also the time
on the Stock 1997 to 2012 perspective to
Market in conduct the
Zambia study is yet
another
constraint.
The Effect Badullahe Data is Time Series Regressi An This study is
of wage collected from Linear on of the existence only to see the
Macroecono (2018) the Colombo Regression log of the impact of
mics Factors Consumer model strong macroeconomi
on The Price Index and connection c variables on
Performance from 1990 to pivotal between stock market
of Stock 2012 role in the performance
Market In the stock macroecon but does not
Sri Lanka market omic predict.
perform factors and
ance of the stock
Sri market
Lanka

2.6 Summary
Most areas' economies have slowed. Under national expansion, the areas of Bali,
Kalimantan, and Maluku, Papua, expanded. There is a considerable slowdown in all
spending components. The rate of increase in household consumption has decreased to
2.8 percent. Export and import performance also suffered because of slowed cross-
border commerce. Imports fell by 2.2 percent, while exports increased by 0.2 percent.
The primary sectors of Indonesia's economy are slowing, while the service sector is
accelerating. In the current quarter, the health industry expanded by up to 10%. This
performance is linked to the COVID-19 epidemic, which has increased demand for
health services.

13
From a monetary standpoint, the Rupiah weakened significantly between February and
March because to global financial market circumstances that were affected by the
pandemic's unpredictability. Despite erratic price inflation exceeding 6%, domestic
inflation remained under control and steady in the range of around 1-3 percent.
Inflation is the tendency for an increase in the price of products circulating in society
as a whole (Tandelin, 2017). The occurrence of inflation has several effects on the
economy, one of which is investing in stocks. Inflation makes investors as financiers
reduce their investment interest in companies listed on the Indonesia Stock Exchange
so that it affects the movement of the ICI. A high inflation rate will cause an increase
in operating expenses on the company, which will result in a decrease in company
profits. As a result, dividends will be distributed to troubled shareholders could
experience a drop or not distributed as it will be retained earnings to be used as working
capital.

Exchange rates or foreign exchange rates are foreign currencies or other means of
payment used to carry out or finance international financial, economic transactions and
have an official rate record at the central bank (Putong, 2013). Dollars will be bought
when the rupiah tends to weaken and sold when the rupiah strengthens. This also
applies to the stock price index; when the stock price index, which is classified as good,
weakens, investors will take high buying action and sell it back when the index rises;
this stock selling action triggers a decline in ICI (Kumalasari, 2016).

14
 CHAPTER 3

RESEARCH METHODOLOGY

3.1 Introduction
Time series data is a type of data that is arranged in chronological order or data
collected from time to time. If time is considered to be discrete (time can be modeled
as continuous), then the frequency of data collection is always the same (equidistant)
(Setiawan, 2018). This research is an empirical study conducted to propose the suitable
model for forecast the ICI during the COVID-19 pandemic in Indonesia based on
Inflation and Exchange Rate. ICI variable data is obtained from IDX monthly statistical
data. Data for inflation and exchange rates are obtained through Bank Indonesia.

3.2 Research Approach

Figure 3.1 depicts a schematic depiction of the entire research approach presented in
this research. The data collection, data preparation, model creation, and model
assessment are the essential steps in this research approach. The next sections go
through each of these important stages as well as the techniques used.

15
 Figure 1. Framework Research

3.2.1 Data Collection

Data collection techniques are the main part of the research. The main objective of this
research is to obtain valid data. Data collection can be done in a variety of settings,
multiple sources, and a variety of ways. This study uses documentation techniques by
utilizing published reports that can be accessed publicly on the online siters of the
Indonesia Stock Exchange and Bank Indonesia.

16
3.2.2 Description of Dataset
The dependent variable in this study is the Indonesia Composite Index (ICI). ICI is a
stock market index used by the Indonesia Stock Exchange. This study will use monthly
closing data obtained from Yahoo Finance. The first independent variable, inflation is
the tendency of an increase in overall product prices. Data regarding the inflation rate
is obtained from statistical data from Bank Indonesia for the period March 2019 to
November 2021 (month to month) which can be obtained from the Indonesia center.
The second independent variable is the Exchange Rate of the Rupiah against the US
Dollar. The Rupiah exchange rate used in this study is the exchange rate at the end of
each month. Exchange rate data will be obtained from the official statistical website of
the Indonesian Ministry of Home Affairs.

3.2.3 Data Preparation

3.2.3.1 Data Pre-Processing
Data pre-processing is an important stage in Machine Learning because the quality of
data and the useful information that can be retrieved from it has a direct influence on
the model's learning ability; hence, data must be pre-processed before being fed into
the model (Kumar, 2018). Data pre-processing improves the model's fit by enriching
the data. This would aid in improving the model's result accuracy. As a result, the data
gathered for this investigation will be pre-processed to meet the needs of this study.
Variable selection, data transformation, and data cleansing are all part of the data pre-
processing for this study.

3.2.3.2 Exploratory Data Analysis

According to Misha (2020), techniques such as transformation, visualization and
modelling are basic tools of EDA to gain meaningful insights from the dataset. By
exploring the dataset with visualization, it helps data analysts to understand the dataset
easily. In this research because the data used is time-series, this stage will be referred
to as an exploratory analysis of time series data. Graphical visualization representation
will be beneficial to find the relationship between variables in the time series data
(Sadahiro & Kobayashi, 2014).

17
Data exploration is carried out at this step utilising statistics, mathematical functions,
and graphs that have been displayed. The data and key data patterns will be easier to
grasp using EDA. The data being examined is either clean or has gone through the pre-
processing stage. There are no more outliers or missing values, indicating that the data
is ready to be processed/analysed at the categorization model-building stage. For this
data, classification is one of the most important and successful analytical approaches.

3.2.3.3 Test for Causation

The causality test is a test to determine the causal relationship between variables in a
model. The causality aims to see the effect between variables both long term and short
term as well. The existence of relationship between variables does not prove causality
or influence so that to find out whether there is a one-way or two-way influence, it is
necessary to test causality (Febrianti et al., 2021).

Before building the model, the Granger causality test was used to determine the
relationship between variables. Granger's causalities are used to test the null hypothesis
that the coefficient of the preceding value in the regression equation is zero. Simply
said, the ICI value is not influenced by previous inflation and exchange rate values. As
a consequence, if the p-value obtained by the test is less than the significance level of
0.05, the null hypothesis may be firmly rejected (Prabhakaran, 2019).

3.2.4 Model Creation

Forecasting data using time-series analysis entails utilising a significant model to
predict future even based on known previous results. Time series analysis has as one
goal the exploration and understanding of patterns in changes through time, where these
patterns represent the components of a time series such as trends, cycles, and irregular
motions. When such components are present in a time series, the data model must
account for them to provide reliable projections, as ICI did in this study. Three time
series models will be built and compared to find the best model that can accurately
predict ICI.

18
First model is Vector Auto Regression (VAR). When two or more time-series interact,
VAR is a multivariate forecasting technique that is employed. The delays of time series
are treated as a linear combination. In other words, the series' historical values are
utilised to forecast the current and future values (Prabhakaran, 2019). The VAR model
has shown to be very effective for explaining and forecasting the dynamic behaviour
of economic and financial tie series. The VAR mode is utilised for structural inference
and strategy analysis in addition to data description and prediction. Certain
assumptions are put on the causal structure of survey data in structural analysis (Pin,
2006).

Second model is Long Short-Term Memory (LSTM). The Recurrent Neural Network
was used to create the LSTM. The memory cell, forget gate, and input gate are all
components of the LSTM, which uses previous time variables as observations. The
LSTM’s structure allows gradients to shift over several time-steps while the
information remains in the same time-step (Huang, 2018). In one cell the LSTM has a
function to compute the hidden state. Cells in the LSTM can decide what to store and
delete in memory (forget gate layer). In addition to being able to combine current
information with previous information, LSTMs are very efficient at recording long
information.

Third model is Autoregressive Conditional Heteroskedasticity (ARCH). ARCH models

are used to describe a variable that is dynamic and perhaps volatile. An ARCH model
may be used to explain a steady increase in variance over time, although it is most
commonly employed to explain abrupt spikes in variance. Transforming the variable
might be a better method to deal with steadily increasing variance and a steadily rising
mean level. ARCH models are frequently referred to as models for that type of variable
since they were created to tackle econometric and financial problems concerning the
amount that investments or stocks grow (or fall) over time. Any series with periods of
increased or decreased variation might benefit from an ARCH model (The
Pennsylvania State University, 2020).

19
3.2.5 Model Assessment
The pre-processed and explored dataset will be split into two groups: training data and
testing data. The data will be utilised to train 75% of the time and test 25% of the time.
The model would be trained to generate predictions using the training data to learn the
patterns in the dataset. Testing data is given to the model after it has been fully trained,
and it is supposed to generate predictions based on the qualities in the testing data.

The forecasting models carried out are then validated using several indicators. In this
research, the indicator used to validate the model is the Mean Squared Error (MSE).
Aims of MSE to tell how close the regression line is to a set of points. This approach
manages large forecasting errors because the errors are squared. MSE is a technique
for determining how close estimations or projections are to actual values. The lower
the MSE, the more accurate the forecast. Mean Squared Error is the average of forecast
errors squared, or if written in the form of a formula is:
𝑛
1 2
𝑀𝑆𝐸 = ∑(𝑌𝑖 − 𝑌̂𝑖 )
𝑛
𝑖=1

3.3 Summary
This chapter explains the research method used in this study. Data collection, data
preparation (data pre-processing and data exploration), model creation, and model
assessment are the steps in the research framework that are highlighted. This chapter
explains the theoretical principles and motivations underlying each stage of data
analysis and model building. In this study, the three models time series forecasting will
ideally be created, evaluated, and compared utilising data collected and processed in
the early phases. The principles and reasoning behind the proposed approach have been
extensively presented in this chapter and implementation-specific details will be
explored in the following chapter.

20
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Appendix A: Fast-Track Form

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Appendix B: Log Sheet

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