Chapter 5 IST 111

Analytics in Action 203
AnAlytics in Action
FORECASTING DEMAND FOR A BROAD LINE OF OFFICE PRODUCTS*
ACCO Brands Corporation is one of the world’s largest the product to getting the product on the shelves to align
suppliers of branded office and consumer products and with the forecasted demand; this can potentially take
print finishing solutions. The company’s widely recog- several months, so the accuracy of our forecasts is criti-
nized brands include AT-A-GLANCE®, Day-Timer®, cal throughout each step of the supply chain. Adding to
this challenge is the risk of obsolescence. We sell many
Five Star®, GBC®, Hilroy®, Kensington®, Marbig®,
dated items, such as planners and calendars, which have
Mead®, NOBO, Quartet®, Rexel, Swingline®, Tilibra®,
a natural, built-in obsolescence. In addition, many of
Wilson Jones®, and many others.
our products feature designs that are fashion-conscious
Because it produces and markets a wide array of prod- or contain pop culture images, and these products can
ucts with a myriad of demand characteristics, ACCO Brands also become obsolete very quickly as tastes and popu-
relies heavily on sales forecasts in planning its manufactur- larity change. An overly optimistic forecast for these
ing, distribution, and marketing activities. By viewing its products can be very costly, but an overly pessimis-
relationship in terms of a supply chain, ACCO Brands and tic forecast can result in lost sales potential and give
its customers (which are generally retail chains) establish our competitors an opportunity to take market share
close collaborative relationships and consider each other to from us.
be valued partners. As a result, ACCO Brands’ custom-
In addition to looking at trends, seasonal compo-
ers share valuable information and data that serve as inputs
nents, and cyclical patterns, Baker and Marks must con-
into ACCO Brands’ forecasting process.
tend with several other factors. Baker notes, “We have
In her role as a forecasting manager for ACCO
to adjust our forecasts for upcoming promotions by our
Brands, Vanessa Baker appreciates the importance of
customers.” Marks agrees and adds:
this additional information. “We do separate forecasts of
demand for each major customer,” said Baker, “and we We also have to go beyond just forecasting consumer
generally use twenty-four to thirty-six months of history demand; we must consider the retailer’s specific needs
to generate monthly forecasts twelve to eighteen months in our order forecasts, such as what type of display will
into the future. While trends are important, several of our be used and how many units of a product must be on
display to satisfy their presentation requirements. Cur-
major product lines, including school, planning and orga-
rent inventory is another factor—if a customer is car-
nizing, and decorative calendars, are heavily seasonal, and
rying either too much or too little inventory, that will
seasonal sales make up the bulk of our annual volume.”
affect their future orders, and we need to reflect that
Daniel Marks, one of several account-level strategic in our forecasts. Will the product have a short life be-
forecast managers for ACCO Brands, adds, cause it is tied to a cultural fad? What are the retailer’s
The supply chain process includes the total lead time marketing and markdown strategies? Our knowledge
from identifying opportunities to making or procuring of the environments in which our supply chain partners
are competing helps us to forecast demand more accu-
*The authors are indebted to Vanessa Baker and Daniel Marks of ACCO rately, and that reduces waste and makes our custom-
Brands for providing input for this Analytics in Action. ers, as well as ACCO Brands, far more profitable.
The purpose of this chapter is to provide an introduction to time series analysis and forecast-
ing. Suppose we are asked to provide quarterly forecasts of sales for one of our company’s
products over the coming one-year period. Production schedules, raw materials purchasing,
inventory policies, marketing plans, and cash flows will all be affected by the quarterly fore-
casts we provide. Consequently, poor forecasts may result in poor planning and increased
costs for the company. How should we go about providing the quarterly sales forecasts?
Good judgment, intuition, and an awareness of the state of the economy may give us a rough
idea, or feeling, of what is likely to happen in the future, but converting that feeling into a
number that can be used as next year’s sales forecast is challenging.
204 Chapter 5 Time Series Analysis and Forecasting
A forecast is simply a pre- Forecasting methods can be classified as qualitative or quantitative. Qualitative meth-
diction of what will happen ods generally involve the use of expert judgment to develop forecasts. Such methods are
in the future. Managers
must accept that regardless
appropriate when historical data on the variable being forecast are either unavailable or not
of the technique used, they applicable. Quantitative forecasting methods can be used when (1) past information about
will not be able to develop the variable being forecast is available, (2) the information can be quantified, and (3) it is
perfect forecasts. reasonable to assume that past is prologue (i.e. the pattern of the past will continue into
the future). We will focus exclusively on quantitative forecasting methods in this chapter.
If the historical data are restricted to past values of the variable to be forecast, the fore-
casting procedure is called a time series method and the historical data are referred to as
time series. The objective of time series analysis is to uncover a pattern in the time series
and then extrapolate the pattern into the future; the forecast is based solely on past values
of the variable and/or on past forecast errors.
Causal or exploratory forecasting methods are based on the assumption that the variable
we are forecasting has a cause-effect relationship with one or more other variables. These
methods help explain how the value of one variable impacts the value of another. For instance,
the sales volume for many products is influenced by advertising expenditures, so regression
analysis may be used to develop an equation showing how these two variables are related.
Then, once the advertising budget is set for the next period, we could substitute this value
into the equation to develop a prediction or forecast of the sales volume for that period. Note
that if a time series method was used to develop the forecast, advertising expenditures would
not be considered; that is, a time series method would base the forecast solely on past sales.
Modern data-collection technologies have enabled individuals, businesses, and govern-
ment agencies to collect vast amounts of data that may be used for causal forecasting. For
example, supermarket scanners allow retailers to collect point-of-sale data that can then
be used to help aid in planning sales, coupon targeting, and other marketing and planning
efforts. These data can help answer important questions like which products tend to be pur-
chased together? One of the techniques used to answer such questions is regression analy-
sis. In this chapter we discuss the use of regression analysis as a causal forecasting method.
In Section 5.1 we discuss the various kinds of time series that a forecaster might be
faced with in practice. These include a constant or horizontal pattern, a trend, a seasonal
pattern, both a trend and a seasonal pattern, and a cyclical pattern. To build a quantitative
forecasting model it is also necessary to have a measurement of forecast accuracy. Different
measurements of forecast accuracy, as well as their respective advantages and disadvan-
tages, are discussed in Section 5.2. In Section 5.3 we consider the simplest case, which is
a horizontal or constant pattern. For this pattern, we develop the classical moving average,
weighted moving average, and exponential smoothing models. Many time series have a
trend, and taking this trend into account is important; in Section 5.4 we provide regression
models for finding the best model parameters when a linear trend is present, when the data
show a seasonal pattern, or when the variable to be predicted has a causal relationship with
other variables. Finally, in Section 5.5 we discuss considerations to be made when deter-
mining the best forecasting model to use.
NOTES AND COMMENTS
Virtually all large companies today rely on enter- plan for the future. SAP, one of the most widely
prise resource planning (ERP) software to aid their used ERP systems includes a forecasting compo-
planning and operations. These software systems nent. This module allows the user to select from a
help the business run smoothly by collecting and number of forecasting techniques and/or have the
efficiently storing company data, enabling it to be system find a “best” model. The various forecasting
shared company-wide for planning at all levels: methods and ways to measure the quality of a fore-
strategically, tactically, and operationally. Most casting model discussed in this chapter are routinely
ERP systems include a forecasting module to help available in software that supports forecasting.
5.1 Time Series Patterns 205
5.1 Time Series Patterns

We limit our discussion to A time series is a sequence of observations on a variable measured at successive points in
time series for which the time or over successive periods of time. The measurements may be taken every hour, day,
values of the series are week, month, year, or any other regular interval. The pattern of the data is an important
recorded at equal intervals.
Cases in which the observa- factor in understanding how the time series has behaved in the past. If such behavior can
tions are made at unequal be expected to continue in the future, we can use it to guide us in selecting an appropriate
intervals are beyond the forecasting method.
scope of this text. To identify the underlying pattern in the data, a useful first step is to construct a time
series plot, which is a graphical presentation of the relationship between time and the time
In Chapter 2 we discussed series variable; time is represented on the horizontal axis and values of the time series vari-
line charts, which are often able are shown on the vertical axis. Let us first review some of the common types of data
used to graph time series.
patterns that can be identified in a time series plot.
Horizontal Pattern
A horizontal pattern exists when the data fluctuate randomly around a constant mean over
WEB file time. To illustrate a time series with a horizontal pattern, consider the 12 weeks of data in
Table 5.1. These data show the number of gallons of gasoline (in 1000s) sold by a gasoline
distributor in Bennington, Vermont, over the past 12 weeks. The average value or mean
Gasoline
for this time series is 19.25 or 19,250 gallons per week. Figure 5.1 shows a time series
plot for these data. Note how the data fluctuate around the sample mean of 19,250 gallons.
Although random variability is present, we would say that these data follow a horizontal
pattern.
The term stationary time series is used to denote a time series whose statistical proper-
ties are independent of time. In particular this means that
1. The process generating the data has a constant mean.
2. The variability of the time series is constant over time.
For a formal definition of A time series plot for a stationary time series will always exhibit a horizontal pattern with
stationarity, see K. Ord random fluctuations. However, simply observing a horizontal pattern is not sufficient evi-
and R. Fildes, Principles dence to conclude that the time series is stationary. More advanced texts on forecasting
of Business Forecasting
(Mason, OH: Cengage discuss procedures for determining whether a time series is stationary and provide methods
Learning, 2012), p. 155. for transforming a nonstationary time series into a stationary series.
TABLE 5.1 GASOLINE SALES TIME SERIES
Sales
Week (1000s of gallons)
1 17
2 21
3 19
4 23
5 18
6 16
7 20
8 18
9 22
10 20
11 15
12 22
FIGURE 5.1 GASOLINE SALES TIME SERIES PLOT
25
20
Sales (1000s of gallons)

15
10
© Cengage Learning 2015

0
0 1 2 3 4 5 6 7 8 9 10 11 12
Week
Changes in business conditions often result in a time series with a horizontal pat-
tern that shifts to a new level at some point in time. For instance, suppose the gasoline
distributor signs a contract with the Vermont State Police to provide gasoline for state
police cars located in southern Vermont beginning in week 13. With this new contract,
the distributor naturally expects to see a substantial increase in weekly sales starting
in week 13. Table 5.2 shows the number of gallons of gasoline sold for the original
time series and the ten weeks after signing the new contract. Figure 5.2 shows the cor-
responding time series plot. Note the increased level of the time series beginning in
week 13. This change in the level of the time series makes it more difficult to choose
an appropriate forecasting method. Selecting a forecasting method that adapts well to
TABLE 5.2 GASOLINE SALES TIME SERIES AFTER OBTAINING THE

CONTRACT WITH THE VERMONT STATE POLICE
Sales Sales
Week (1000s of gallons) Week (1000s of gallons)
1 17 12 22
2 21 13 31
3 19 14 34
WEB file 4
5
23
18
15
16
31
33
6 16 17 28
GasolineRevised
7 20 18 32
8 18 19 30
9 22 20 29
10 20 21 34
11 15 22 33
FIGURE 5.2 GASOLINE SALES TIME SERIES PLOT AFTER OBTAINING THE
CONTRACT WITH THE VERMONT STATE POLICE
40
35
30
25
20
15
10
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Week
changes in the level of a time series is an important consideration in many practical

applications.
Trend Pattern
Although time series data generally exhibit random fluctuations, a time series may also
show gradual shifts or movements to relatively higher or lower values over a longer period
of time. If a time series plot exhibits this type of behavior, we say that a trend pattern
exists. A trend is usually the result of long-term factors such as population increases or
decreases, shifting demographic characteristics of the population, improving technology,
changes in the competitive landscape, and/or changes in consumer preferences.
To illustrate a time series with a linear trend pattern, consider the time series
of bicycle sales for a particular manufacturer over the past ten years, as shown in
Table 5.3 and Figure 5.3. Note that 21,600 bicycles were sold in year 1, 22,900 were
TABLE 5.3 BICYCLE SALES TIME SERIES
Year Sales (1000s)

1 21.6
2 22.9
3 25.5
WEB file 4 21.9
5 23.9
Bicycle 6 27.5
7 31.5
8 29.7
9 28.6
10 31.4
FIGURE 5.3 BICYCLE SALES TIME SERIES PLOT
34
32
30
Sales (1000s)
28
26
24
22
20
0 1 2 3 4 5 6 7 8 9 10
Year
sold in year 2, and so on. In year ten, the most recent year, 31,400 bicycles were sold.
Visual inspection of the time series plot shows some up-and-down movement over
the past ten years, but the time series seems also to have a systematically increasing
or upward trend.
The trend for the bicycle sales time series appears to be linear and increasing over
time, but sometimes a trend can be described better by other types of patterns. For in-
stance, the data in Table 5.4 and the corresponding time series plot in Figure 5.4 show the
sales revenue for a cholesterol drug since the company won FDA approval for the drug
ten years ago. The time series increases in a nonlinear fashion; that is, the rate of change
of revenue does not increase by a constant amount from one year to the next. In fact,
the revenue appears to be growing in an exponential fashion. Exponential relationships
TABLE 5.4 CHOLESTEROL DRUG REVENUE TIME SERIES
Year Revenue ($ millions)

1 23.1
2 21.3
3 27.4
WEB file 4 34.6
5 33.8
Cholesterol 6 43.2
7 59.5
8 64.4
9 74.2
10 99.3
FIGURE 5.4 CHOLESTEROL DRUG REVENUE TIMES SERIES PLOT ($ MILLIONS)
120
100
80
Revenue
60
40
20
0
0 1 2 3 4 5 6 7 8 9 10
Year
such as this are appropriate when the percentage change from one period to the next is
relatively constant.
Seasonal Pattern
The trend of a time series can be identified by analyzing movements in historical data over
multiple time periods. Seasonal patterns are recognized by observing recurring patterns
over successive periods of time. For example, a manufacturer of swimming pools expects
low sales activity in the fall and winter months, with peak sales in the spring and summer
months to occur every year. Manufacturers of snow removal equipment and heavy clothing,
however, expect the opposite yearly pattern. Not surprisingly, the pattern for a time series
plot that exhibits a recurring pattern over a one-year period due to seasonal influences is
called a seasonal pattern. Although we generally think of seasonal movement in a time
series as occurring within one year, time series data can also exhibit seasonal patterns of
less than one year in duration. For example, daily traffic volume shows within-the-day “sea-
sonal” behavior, with peak levels occurring during rush hours, moderate flow during the
rest of the day and early evening, and light flow from midnight to early morning. Another
example of an industry with sales that exhibit easily discernible seasonal patterns within a
day is the restaurant industry.
As an example of a seasonal pattern, consider the number of umbrellas sold at a
clothing store over the past five years. Table 5.5 shows the time series and Figure 5.5
shows the corresponding time series plot. The time series plot does not indicate a long-
term trend in sales. In fact, unless you look carefully at the data, you might conclude
that the data follow a horizontal pattern with random fluctuation. However, closer
inspection of the fluctuations in the time series plot reveals a systematic pattern in the
data that occurs within each year. Specifically, the first and third quarters have moder-
ate sales, the second quarter has the highest sales, and the fourth quarter tends to have
the lowest sales volume. Thus, we would conclude that a quarterly seasonal pattern is
present.
Trend and Seasonal Pattern

Some time series include both a trend and a seasonal pattern. For instance, the data in
Table 5.6 and the corresponding time series plot in Figure 5.6 show quarterly smartphone
TABLE 5.5 UMBRELLA SALES TIME SERIES
Year Quarter Sales

1 1 125
2 153
3 106
4 88
2 1 118
2 161
3 133
4 102
WEB file 3 1 138
2 144
Umbrella 3 113
4 80
4 1 109
2 137
3 125
4 109
5 1 130
2 165
3 128
4 96
FIGURE 5.5 UMBRELLA SALES TIME SERIES PLOT
180
160
140
120
100
Sales
80
60
40
20
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Time Period
sales for a particular manufacturer over the past four years. Clearly an increasing trend is
present. However, Figure 5.6 also indicates that sales are lowest in the second quarter of
each year and highest in quarters 3 and 4. Thus, we conclude that a seasonal pattern also ex-
ists for smartphone sales. In such cases we need to use a forecasting method that is capable
of dealing with both trend and seasonality.
TABLE 5.6 QUARTERLY SMARTPHONE SALES TIME SERIES
Year Quarter Sales ($1000s)

1 1 4.8
2 4.1
3 6.0
4 6.5
2 1 5.8
WEB file 2
3
5.2
6.8
4 7.4
SmartPhoneSales 3 1 6.0
2 5.6
3 7.5
4 7.8
4 1 6.3
2 5.9
3 8.0
4 8.4
FIGURE 5.6 QUARTERLY SMARTPHONE SALES TIME SERIES PLOT
9.0
8.0
Quarterly Smartphone Sales ($1000s)
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
0 2 4 6 8 10 12 14 16 18
Period
Cyclical Pattern
A cyclical pattern exists if the time series plot shows an alternating sequence of points
below and above the trendline that lasts for more than one year. Many economic time
series exhibit cyclical behavior with regular runs of observations below and above the
trendline. Often the cyclical component of a time series is due to multiyear business cy-
cles. For example, periods of moderate inflation followed by periods of rapid inflation can
lead to a time series that alternates below and above a generally increasing trendline (e.g.,
a time series for housing costs). Business cycles are extremely difficult, if not impossible,
to forecast. As a result, cyclical effects are often combined with long-term trend effects and
referred to as trend-cycle effects. In this chapter we do not deal with cyclical effects that
may be present in the time series.
Identifying Time Series Patterns

The underlying pattern in the time series is an important factor in selecting a forecast-
ing method. Thus, a time series plot should be one of the first analytic tools employed
when trying to determine which forecasting method to use. If we see a horizontal pat-
tern, then we need to select a method appropriate for this type of pattern. Similarly, if
we observe a trend in the data, then we need to use a forecasting method that is capable
of handling a trend effectively. In the next section we discuss methods for assessing
forecast accuracy. We then consider forecasting models that can be used in situations
for which the underlying pattern is horizontal; in other words, no trend or seasonal ef-
fects are present. We then consider methods appropriate when trend and/or seasonality
are present in the data.
5.2 Forecast Accuracy

In this section we begin by developing forecasts for the gasoline time series shown in
Table 5.1 using the simplest of all the forecasting methods. We use the most recent
week’s sales volume as the forecast for the next week. For instance, the distributor sold
17 thousand gallons of gasoline in week 1; this value is used as the forecast for week 2.
Next, we use 21, the actual value of sales in week 2, as the forecast for week 3, and so on.
The forecasts obtained for the historical data using this method are shown in Table 5.7
in the Forecast column. Because of its simplicity, this method is often referred to as a
naïve forecasting method.
TABLE 5.7 COMPUTING FORECASTS AND MEASURES OF FORECAST ACCURACY USING THE MOST
RECENT VALUE AS THE FORECAST FOR THE NEXT PERIOD
Time Absolute Value Squared Absolute Value

Series Forecast of Forecast Forecast Percentage of Percentage
Week Value Forecast Error Error Error Error Error
1 17
2 21 17 4 4 16 19.05 19.05
3 19 21 22 2 4 210.53 10.53
4 23 19 4 4 16 17.39 17.39
5 18 23 25 5 25 227.78 27.78
6 16 18 22 2 4 212.50 12.50
7 20 16 4 4 16 20.00 20.00
8 18 20 22 2 4 211.11 11.11
9 22 18 4 4 16 18.18 18.18
10 20 22 22 2 4 210.00 10.00
11 15 20 25 5 25 233.33 33.33
12 22 15 7 7 49 31.82 31.82
Totals 5 41 179 1.19 211.69
5.2 Forecast Accuracy 213
How accurate are the forecasts obtained using this naïve forecasting method? To
answer this question, we will introduce several measures of forecast accuracy. These
measures are used to determine how well a particular forecasting method is able to
reproduce the time series data that are already available. By selecting the method that
is most accurate for the data already known, we hope to increase the likelihood that we
will obtain more accurate forecasts for future time periods. The key concept associated
with measuring forecast accuracy is forecast error. If we denote yt and y^t as the actual
and forecasted values of the time series for period t, respectively, the forecasting error
for period t is
FORECAST ERROR
et 5 yt 2 y^t (5.1)
That is, the forecast error for time period t is the difference between the actual and the
forecasted values for period t.
For instance, because the distributor actually sold 21 thousand gallons of gasoline in
week 2, and the forecast, using the sales volume in week 1, was 17 thousand gallons, the
forecast error in week 2 is
Forecast Error in week 2 5 e2 5 y2 2 y^2 5 21 2 17 5 4
A positive error such as this indicates that the forecasting method underestimated the actual
value of sales for the associated period. Next we use 21, the actual value of sales in week 2,
as the forecast for week 3. Since the actual value of sales in week 3 is 19, the forecast error
for week 3 is e3 5 19 2 21 5 22. In this case, the negative forecast error indicates the
forecast overestimated the actual value for week 3. Thus, the forecast error may be positive
or negative, depending on whether the forecast is too low or too high. A complete summary
of the forecast errors for this naïve forecasting method is shown in Table 5.7 in the Forecast
Error column. It is important to note that because we are using a past value of the time series
to produce a forecast for period t, we do not have sufficient data to produce a naïve forecast
for the first week of this time series.
A simple measure of forecast accuracy is the mean or average of the forecast errors.
If we have n periods in our time series and k is the number of periods at the beginning
of the time series for which we cannot produce a naïve forecast, the mean forecast error
(MFE) is
MEAN FORECAST ERROR (MFE)
a et
n
t5k11
MFE 5 (5.2)
n2k
Table 5.7 shows that the sum of the forecast errors for the gasoline sales time series is
5; thus, the mean or average error is 5/11 5 0.45. Because we do not have sufficient
data to produce a naïve forecast for the first week of this time series, we must adjust
our calculations in both the numerator and denominator accordingly. This is common in
forecasting; we often use k past periods from the time series to produce forecasts, and
so we frequently cannot produce forecasts for the first k periods. In those instances the
summation in the numerator starts at the first value of t for which we have produced a
forecast (so we begin the summation at t 5 k 1 1), and the denominator (which is the
number of periods in our time series for which we are able to produce a forecast) will also
reflect these circumstances. In the gasoline example, although the time series consists of
n 5 12 values, to compute the mean error we divided the sum of the forecast errors by
11 because there are only 11 forecast errors (we cannot generate forecast sales for the
first week using this naïve forecasting method).
Also note that in the gasoline time series, the mean forecast error is positive, implying
that the method is generally underforecasting; in other words, the observed values tend to
be greater than the forecasted values. Because positive and negative forecast errors tend to
offset one another, the mean error is likely to be small; thus, the mean error is not a very
useful measure of forecast accuracy.
The mean absolute error (MAE) is a measure of forecast accuracy that avoids the
problem of positive and negative forecast errors offsetting one another. As you might ex-
pect given its name, MAE is the average of the absolute values of the forecast errors:
MEAN ABSOLUTE ERROR (MAE)
a 0 et 0
n
t5k11
MAE 5 (5.3)
n2k
This is also referred to as the mean absolute deviation (MAD). Table 5.7 shows that the sum
of the absolute values of the forecast errors is 41; thus
41
MAE 5 average of the absolute value of the forecast errors 5 5 3.73
11
Another measure that avoids the problem of positive and negative errors offsetting each
other is obtained by computing the average of the squared forecast errors. This measure of
forecast accuracy is referred to as the mean squared error (MSE):
MEAN SQUARED ERROR (MSE)
a et
n
2
t5k11
MSE 5 (5.4)
n2k
From Table 5.7, the sum of the squared errors is 179; hence,
179
MSE 5 average of the square of the forecast errors 5 5 16.27
11
The size of MAE or MSE depends upon the scale of the data. As a result, it is difficult to
make comparisons for different time intervals (such as comparing a method of forecasting
5.2 Forecast Accuracy 215
monthly gasoline sales to a method of forecasting weekly sales) or to make comparisons

across different time series (such as monthly sales of gasoline and monthly sales of oil fil-
ters). To make comparisons such as these we need to work with relative or percentage error
measures. The mean absolute percentage error (MAPE) is such a measure. To calculate
MAPE we use the formula:
MEAN ABSOLUTE PERCENTAGE ERROR (MAPE)
a ` a y b100`
n
et
t5k11 t
MAPE 5 (5.5)
n2k
Table 5.7 shows that the sum of the absolute values of the percentage errors is
a ` a y b100` 5 211.69
12
et
t5111 t
Thus the MAPE, which is the average of the absolute value of percentage forecast errors, is
211.69
5 19.24%
11
In summary, using the naïve (most recent observation) forecasting method, we obtain
the following measures of forecast accuracy:
MAE 5 3.73
MSE 5 16.27
MAPE 5 19.24%
These measures of forecast accuracy simply measure how well the forecasting method is
able to forecast historical values of the time series. Now, suppose we want to forecast sales
for a future time period, such as week 13. The forecast for week 13 is 22, the actual value of
the time series in week 12. Is this an accurate estimate of sales for week 13? Unfortunately
there is no way to address the issue of accuracy associated with forecasts for future time
periods. However, if we select a forecasting method that works well for the historical data,
and we have reason to believe the historical pattern will continue into the future, we should
obtain forecasts that will ultimately be shown to be accurate.
Before closing this section, let us consider another method for forecasting the gasoline
sales time series in Table 5.1. Suppose we use the average of all the historical data avail-
able as the forecast for the next period. We begin by developing a forecast for week 2.
Because there is only one historical value available prior to week 2, the forecast for week 2
is just the time series value in week 1; thus, the forecast for week 2 is 17 thousand gallons
of gasoline. To compute the forecast for week 3, we take the average of the sales values in
weeks 1 and 2. Thus,
17 1 21
y^3 5 5 19
2
Similarly, the forecast for week 4 is
17 1 21 1 19
y^4 5 5 19
3
TABLE 5.8 COMPUTING FORECASTS AND MEASURES OF FORECAST ACCURACY USING THE
AVERAGE OF ALL THE HISTORICAL DATA AS THE FORECAST FOR THE NEXT PERIOD

1 17
2 21 17.00 4.00 4.00 16.00 19.05 19.05
3 19 19.00 0.00 0.00 0.00 0.00 0.00
4 23 19.00 4.00 4.00 16.00 17.39 17.39
5 18 20.00 22.00 2.00 4.00 211.11 11.11
6 16 19.60 23.60 3.60 12.96 222.50 22.50
7 20 19.00 1.00 1.00 1.00 5.00 5.00
8 18 19.14 21.14 1.14 1.31 26.35 6.35
9 22 19.00 3.00 3.00 9.00 13.64 13.64
10 20 19.33 0.67 0.67 0.44 3.33 3.33
11 15 19.40 24.40 4.40 19.36 229.33 29.33
12 22 19.00 3.00 3.00 9.00 13.64 13.64
Totals 4.52 26.81 89.07 2.75 141.34
The forecasts obtained using this method for the gasoline time series are shown in Table 5.8
in the Forecast column. Using the results shown in Table 5.8, we obtain the following values
of MAE, MSE, and MAPE:
28.81
MAE 5 5 2.44
11
89.07
MSE 5 5 8.10
11
141.34
MAPE 5 5 12.85%
11
We can now compare the accuracy of the two forecasting methods we have considered
in this section by comparing the values of MAE, MSE, and MAPE for each method.
Naïve Method Average of Past Values

MAE 3.73 2.44
MSE 16.27 8.10
MAPE 19.24% 12.85%
For each of these measures, the average of past values provides more accurate forecasts for
the next period than using the most recent observation.
Evaluating different forecasts based on historical accuracy is only helpful if historical
patterns continue in to the future. As we note in Section 5.1, the 12 observations of Table 5.1
comprise a stationary time series. In Section 5.1 we also mentioned that changes in business
conditions often result in a time series that is not stationary. We discussed a situation in which
the gasoline distributor signed a contract with the Vermont State Police to provide gasoline
for state police cars located in southern Vermont. Table 5.2 shows the number of gallons of
gasoline sold for the original time series and the ten weeks after signing the new contract,
and Figure 5.2 shows the corresponding time series plot. Note the change in level in week 13
for the resulting time series. When a shift to a new level such as this occurs, it takes several
periods for the forecasting method that uses the average of all the historical data to adjust to
the new level of the time series. However, in this case the simple naïve method adjusts very
5.3 Moving Averages and Exponential Smoothing 217
Measures of forecast accuracy are important factors in comparing different forecast-

ing methods, but we have to be careful to not rely too heavily upon them. Good judgment
and knowledge about business conditions that might affect the value of the variable to be
forecast also have to be considered carefully when selecting a method. Historical forecast
accuracy is not the sole consideration, especially if the pattern exhibited by the time series
is likely to change in the future.
In the next section, we will introduce more sophisticated methods for developing fore-
casts for a time series that exhibits a horizontal pattern. Using the measures of forecast
accuracy developed here, we will be able to assess whether such methods provide more
accurate forecasts than we obtained using the simple approaches illustrated in this section.
The methods that we will introduce also have the advantage that they adapt well to situa-
tions in which the time series changes to a new level. The ability of a forecasting method
to adapt quickly to changes in level is an important consideration, especially in short-term
forecasting situations.
5.3 Moving Averages and Exponential Smoothing

In this section we discuss two forecasting methods that are appropriate for a time series
with a horizontal pattern: moving averages and exponential smoothing. These methods are
capable of adapting well to changes in the level of a horizontal pattern such as what we saw
with the extended gasoline sales time series (Table 5.2 and Figure 5.2). However, without
modification they are not appropriate when considerable trend, cyclical, or seasonal effects
are present. Because the objective of each of these methods is to smooth out random fluc-
tuations in the time series, they are referred to as smoothing methods. These methods are
easy to use and generally provide a high level of accuracy for short-range forecasts, such
as a forecast for the next time period.
Moving Averages
The moving averages method uses the average of the most recent k data values in the
time series as the forecast for the next period. Mathematically, a moving average forecast
of order k is
MOVING AVERAGE FORECAST
a yi
t
a ( most recent k data values ) i5t2k11

y^t11 5 5
k k
yt2k11 1 c1 yt21 1 yt
5 (5.6)
k
where
y^t11 5 forecast of the time series for period t 1 1
yt 5 actual value of the time series in period t
k 5 number of periods of time series data used to generate the forecast
The term moving is used because every time a new observation becomes available
for the time series, it replaces the oldest observation in the equation and a new average is
computed. Thus, the periods over which the average is calculated change, or move, with
To illustrate the moving averages method, let us return to the original 12 weeks of
gasoline sales data in Table 5.1 and Figure 5.1. The time series plot in Figure 5.1 indicates
that the gasoline sales time series has a horizontal pattern. Thus, the smoothing methods of
this section are applicable.
To use moving averages to forecast a time series, we must first select the order k, or the
number of time series values to be included in the moving average. If only the most recent
values of the time series are considered relevant, a small value of k is preferred. If a greater
number of past values are considered relevant, then we generally opt for a larger value of k.
As previously mentioned, a time series with a horizontal pattern can shift to a new level over
time. A moving average will adapt to the new level of the series and continue to provide
good forecasts in k periods. Thus a smaller value of k will track shifts in a time series more
quickly (the naïve approach discussed earlier is actually a moving average for k 5 1). On the
other hand, larger values of k will be more effective in smoothing out random fluctuations.
Thus, managerial judgment based on an understanding of the behavior of a time series is
helpful in choosing an appropriate value of k.
To illustrate how moving averages can be used to forecast gasoline sales, we will use a
three-week moving average (k 5 3). We begin by computing the forecast of sales in week
4 using the average of the time series values in weeks 1 to 3.
17 1 21 1 19
y^4 5 average for weeks 1 to 3 5 5 19
3
Thus, the moving average forecast of sales in week 4 is 19 or 19,000 gallons of gaso-
line. Because the actual value observed in week 4 is 23, the forecast error in week 4 is
e4 5 23 2 19 5 4.
We next compute the forecast of sales in week 5 by averaging the time series values
in weeks 2–4.
21 1 19 1 23
3
Hence, the forecast of sales in week 5 is 21 and the error associated with this forecast is
e5 5 18 2 21 5 23. A complete summary of the three-week moving average forecasts for
the gasoline sales time series is provided in Table 5.9. Figure 5.7 shows the original time
TABLE 5.9 SUMMARY OF THREE-WEEK MOVING AVERAGE CALCULATIONS

1 17
2 21
3 19
4 23 19 4 4 16 17.39 17.39
5 18 21 23 3 9 216.67 16.67
6 16 20 24 4 16 225.00 25.00
7 20 19 1 1 1 5.00 5.00
8 18 18 0 0 0 0.00 0.00
9 22 18 4 4 16 18.18 18.18
10 20 20 0 0 0 0.00 0.00
11 15 20 25 5 25 233.33 33.33
12 22 19 3 3 9 13.64 13.64
Totals 0 24 92 220.79 129.21
FIGURE 5.7 GASOLINE SALES TIME SERIES PLOT AND THREE-WEEK

MOVING AVERAGE FORECASTS
25
Sales (1000s of gallons) 20
15
Three-week moving
average forecasts
10
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Week
series plot and the three-week moving average forecasts. Note how the graph of the mov-
ing average forecasts has tended to smooth out the random fluctuations in the time series.
To forecast sales in week 13, the next time period in the future, we simply compute the
average of the time series values in weeks 10, 11, and 12.
20 1 15 1 22
3
Thus, the forecast for week 13 is 19, or 19,000 gallons of gasoline.
To show how Excel can be used to develop forecasts using the moving averages method,
WEB file we develop a forecast for the gasoline sales time series in Table 5.1 and Figure 5.1. We as-
sume that the user has entered the week into rows 2 through 13 of column A and the sales
Gasoline
data for the 12 weeks into worksheet rows 2 through 13 of column B.
The following steps can be used to produce a three-week moving average:
If Data Analysis does not
appear in your Analysis Step 1. Click the DATA tab in the Ribbon
group, you will have to Step 2. Click Data Analysis in the Analysis group
load the Analysis ToolPak Step 3. When the Data Analysis dialog box appears (Figure 5.8), select Moving
Add-in into Excel. To do so,
click the FILE tab in the
Average and click OK
Ribbon and click Options. Step 4. When the Moving Average dialog box appears (Figure 5.9):
When the Excel Options Enter B2:B13 in the Input Range: box
dialog box appears, click Enter 3 in the Interval: box
Add-Ins from the menu. Enter C3 in the Output Range: box
Next to Manage:, select
Excel Add-ins and click
Click OK
Go . . . at the bottom of the Once you have completed this step, the three-week moving average forecasts will ap-
dialog box. When the Add-
Ins dialog box appears,
pear in column C of the worksheet as shown in Figure 5.10. Note that forecasts for
select Analysis ToolPak periods of other lengths can be computed easily by entering a different value in the
and click OK. Interval: box.
FIGURE 5.8 DATA ANALYSIS DIALOG BOX
FIGURE 5.9 MOVING AVERAGE DIALOG BOX
FIGURE 5.10 EXCEL OUTPUT FOR MOVING AVERAGE FORECAST FOR

GASOLINE DATA
A B C
1 Week Sales (1000s of gallons)
2 1 17
3 2 21 #N/A
4 3 19 #N/A
5 4 23 19
6 5 18 21
7 6 16 20
8 7 20 19
9 8 18 18
10 9 22 18
11 10 20 20
12 11 15 20
13 12 22 19
14 13 19
Forecast Accuracy
In Section 5.2 we discussed three measures of forecast accuracy: mean absolute error
(MAE), mean squared error (MSE), and mean absolute percentage error (MAPE). Using
the three-week moving average calculations in Table 5.9, the values for these three mea-
sures of forecast accuracy are
a 0 et 0
n
t5k11 24
MAE 5 5 5 2.67
n2k 9
a et
n
2
t5k11 92
MSE 5 5 5 10.22
n2k 9
a ` a y b100`
n
et
t5k11 t 129.21
MAPE 5 5 5 14.36%
n2k 9
In Section 5.2 we showed that using the most recent observation as the forecast for the
next week (a moving average of order k 5 1) resulted in values of MAE 5 3.73, MSE 5
16.27, and MAPE 5 19.24 percent. Thus, in each case the three-week moving average ap-
proach has provided more accurate forecasts than simply using the most recent observation
as the forecast. Also note how we have revised the formulas for the MAE, MSE, and MAPE
to reflect that our use of a three-week moving average leaves us with insufficient data to
generate forecasts for the first three weeks of our time series.
If a large amount of data To determine whether a moving average with a different order k can provide more
are available to build the accurate forecasts, we recommend using trial and error to determine the value of k that
forecast models, we suggest minimizes the MSE. For the gasoline sales time series, it can be shown that the minimum
dividing the data into train-
ing and validation sets, and
value of MSE corresponds to a moving average of order k 5 6 with MSE 5 6.79. If we
then determining the best are willing to assume that the order of the moving average that is best for the historical
value of k as the value that data will also be best for future values of the time series, the most accurate moving aver-
minimizes the MSE for the age forecasts of gasoline sales can be obtained using a moving average of order k 5 6.
validation set. We discuss
the use of training and vali-
dation sets in more detail in
Exponential Smoothing
Section 5.5. Exponential smoothing uses a weighted average of past time series values as a forecast.
The exponential smoothing model is
EXPONENTIAL SMOOTHING FORECAST:

y^t11 5 αyt 1 ( 1 2 α ) y^t (5.7)
where
y^t11 5 forecast of the time series for period t 1 1
yt 5 actual value of the time series in period t
y^t 5 forecast of the time series for period t
α 5 smoothing constant (0 # a # 1)
Equation (5.7) shows that the forecast for period t 1 1 is a weighted average of the
actual value in period t and the forecast for period t. The weight given to the actual value
in period t is the smoothing constant a, and the weight given to the forecast in period t is
1 2 a. It turns out that the exponential smoothing forecast for any period is actually a
weighted average of all the previous actual values of the time series. Let us illustrate by
working with a time series involving only three periods of data: y1, y2, and y3.
To initiate the calculations, we let y^1 equal the actual value of the time series in period 1;
that is, y^1 5 y1. Hence, the forecast for period 2 is
y^2 5 αy1 1 ( 1 2 α ) y^1
5 αy1 1 ( 1 2 α ) y1
5 y1
We see that the exponential smoothing forecast for period 2 is equal to the actual value of
the time series in period 1.
The forecast for period 3 is
y^3 5 αy2 1 ( 1 2 α ) y^2 5 αy2 1 ( 1 2 α ) y1
Finally, substituting this expression for y^3 into the expression for y^4, we obtain
y^4 5 αy3 1 ( 1 2 α ) y^3
5 αy3 1 ( 1 2 α ) ( αy2 1 ( 1 2 α ) y1 )
5 αy3 1 α ( 1 2 α ) y2 1 ( 1 2 α ) 2y1
We now see that y^4 is a weighted average of the first three time series values. The sum of
the coefficients, or weights, for y1, y2, and y3 equals 1. A similar argument can be made
to show that, in general, any forecast y^t11 is a weighted average of all the t previous time
series values.
Despite the fact that exponential smoothing provides a forecast that is a weighted aver-
age of all past observations, all past data do not need to be retained to compute the forecast
for the next period. In fact, equation (5.7) shows that once the value for the smoothing con-
stant a is selected, only two pieces of information are needed to compute the forecast for
period t 1 1: yt, the actual value of the time series in period t; and y^t, the forecast for period t.
To illustrate the exponential smoothing approach to forecasting, let us again consider
the gasoline sales time series in Table 5.1 and Figure 5.1. As indicated previously, to
initialize the calculations we set the exponential smoothing forecast for period 2 equal
to the actual value of the time series in period 1. Thus, with y1 5 17, we set y^2 5 17 to
initiate the computations. Referring to the time series data in Table 5.1, we find an actual
time series value in period 2 of y2 5 21. Thus, in period 2 we have a forecast error of
e2 5 21 2 17 5 4.
Continuing with the exponential smoothing computations using a smoothing constant
of a 5 0.2, we obtain the following forecast for period 3:
y^3 5 0.2y2 1 0.8y^2 5 0.2 ( 21 ) 1 0.8 ( 17 ) 5 17.8
Once the actual time series value in period 3, y3 5 19, is known, we can generate a forecast
for period 4 as follows.
y^4 5 0.2y3 1 0.8y^3 5 0.2 ( 19 ) 1 0.8 ( 17.8 ) 5 18.04
Continuing the exponential smoothing calculations, we obtain the weekly forecast val-
ues shown in Table 5.10. Note that we have not shown an exponential smoothing forecast or
a forecast error for week 1 because no forecast was made (we used actual sales for week 1
as the forecasted sales for week 2 to initialize the exponential smoothing process). For
week 12, we have y12 5 22 and y^12 5 18.48. We can we use this information to generate a
forecast for week 13.
y^13 5 0.2y12 1 0.8y^12 5 0.2 ( 22 ) 1 0.8 ( 18.48 ) 5 19.18
Thus, the exponential smoothing forecast of the amount sold in week 13 is 19.18, or
19,180 gallons of gasoline. With this forecast, the firm can make plans and decisions
accordingly.
TABLE 5.10 SUMMARY OF THE EXPONENTIAL SMOOTHING FORECASTS

AND FORECAST ERRORS FOR THE GASOLINE SALES TIME
SERIES WITH SMOOTHING CONSTANT a 5 0.2
Time Series Forecast Squared Forecast

Week Value Forecast Error Error
1 17
2 21 17.00 4.00 16.00
3 19 17.80 1.20 1.44
4 23 18.04 4.96 24.60
5 18 19.03 21.03 1.06
6 16 18.83 22.83 8.01
7 20 18.26 1.74 3.03
8 18 18.61 20.61 0.37
9 22 18.49 3.51 12.32
10 20 19.19 0.81 0.66
11 15 19.35 24.35 18.92
12 22 18.48 3.52 12.39
Totals 10.92 98.80
Figure 5.11 shows the time series plot of the actual and forecast time series values.
Note in particular how the forecasts smooth out the irregular or random fluctuations in the
time series.
WEB file To show how Excel can be used for exponential smoothing, we again develop a fore-
cast for the gasoline sales time series in Table 5.1 and Figure 5.1. We use Gasoline file
Gasoline which has the week in rows 2 through 13 of column A and the sales data for the 12 weeks
FIGURE 5.11 ACTUAL AND FORECAST GASOLINE TIME SERIES WITH

SMOOTHING CONSTANT a 5 0.2
25
Actual time
series
20
15
Forecast time series
with a 5 0.2
10
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Week
FIGURE 5.12 DATA ANALYSIS DIALOG BOX
in rows 2 through 13 of column B. We use a 5 0.2. The following steps can be used to
produce a forecast.
Step 1. Click the DATA tab in the Ribbon
Step 2. Click Data Analysis in the Analysis group
Step 3. When the Data Analysis dialog box appears (Figure 5.12), select Exponential
Smoothing and click OK
Step 4. When the Exponential Smoothing dialog box appears (Figure 5.13):
Enter B2:B13 in the Input Range: box
Enter 0.8 in the Damping factor: box
Enter C2 in the Output Range: box
Click OK
Once you have completed this step, the exponential smoothing forecasts will appear in
column C of the worksheet as shown in Figure 5.14. Note that the value we entered in the
Damping factor: box is 1 2 a; forecasts for other smoothing constants can be computed
easily by entering a different value for 1 2 a in the Damping factor: box.
Forecast Accuracy
In the preceding exponential smoothing calculations, we used a smoothing constant of
a 5 0.2. Although any value of a between 0 and 1 is acceptable, some values will yield
FIGURE 5.13 EXPONENTIAL SMOOTHING DIALOG BOX

FIGURE 5.14 EXCEL OUTPUT FOR EXPONENTIAL SMOOTHING FORECAST

FOR GASOLINE DATA
A B C
1 Week Sales (1,000s of gallons)
2 1 17 #N/A
3 2 21 17
4 3 19 17.8
5 4 23 18.04
6 5 18 19.032
7 6 16 18.8256
8 7 20 18.2605
9 8 18 18.6084
10 9 22 18.4867
11 10 20 19.1894
12 11 15 19.3515
13 12 22 18.4812
more accurate forecasts than others. Insight into choosing a good value for a can be
obtained by rewriting the basic exponential smoothing model as follows:
y^t11 5 αyt 1 ( 1 2 α ) y^t
5 αyt 1 y^t 2 αy^t
5 y^t 1 α ( yt 2 y^t ) 5 y^t 1 αet
Thus, the new forecast y^t11 is equal to the previous forecast y^t plus an adjustment, which is
the smoothing constant a times the most recent forecast error, et 5 yt 2 y^t. In other words,
the forecast in period t 1 1 is obtained by adjusting the forecast in period t by a fraction of
the forecast error from period t. If the time series contains substantial random variability,
a small value of the smoothing constant is preferred. The reason for this choice is that if
much of the forecast error is due to random variability, we do not want to overreact and
adjust the forecasts too quickly. For a time series with relatively little random variability,
a forecast error is more likely to represent a real change in the level of the series. Thus,
larger values of the smoothing constant provide the advantage of quickly adjusting the
forecasts to changes in the time series, thereby allowing the forecasts to react more quickly
to changing conditions.
Similar to our note related The criterion we will use to determine a desirable value for the smoothing constant
to moving averages, a is the same as that proposed for determining the order or number of periods of data to
if enough data are avail- include in the moving averages calculation; that is, we choose the value of a that minimizes
able then a should be
chosen to minimize the
the MSE. A summary of the MSE calculations for the exponential smoothing forecast of
MSE of the validation set. gasoline sales with a 5 0.2 is shown in Table 5.10. Note that there is one less squared error
term than the number of time periods; this is because we had no past values with which to
make a forecast for period 1. The value of the sum of squared forecast errors is 98.80; hence
MSE 5 98.80/11 5 8.98. Would a different value of a provide better results in terms of a
lower MSE value? Trial and error is often used to determine whether a different smooth-
ing constant a can provide more accurate forecasts, but we can avoid trial and error and
determine the value of a that minimizes MSE through the use of nonlinear optimization.
Nonlinear optimization is discussed in Chapter 10.
NOTES AND COMMENTS
1. Spreadsheet packages are effective tools for refinements of these methods have been de-
implementing exponential smoothing. With veloped. These include but are not limited to
the time series data and the forecasting for- weighted moving averages, double moving
mulas in a spreadsheet such as the one shown averages, Brown’s method for double ex-
in Table 5.10, you can use the MAE, MSE, ponential smoothing, and triple exponential
and MAPE to evaluate different values of the smoothing. Students who are interested in
smoothing constant a. these and other more advanced methods for
2. Moving averages and exponential smooth- time series analysis are encouraged to read
ing provide the foundation for much of time about them in the references listed at the end
series analysis, and many more sophisticated of this textbook.
5.4 Using Regression Analysis for Forecasting

As we saw in Chapter 4, regression analysis is a statistical technique that can be used to
develop a mathematical equation showing how variables are related. In regression termi-
nology, the variable that is being predicted is called the dependent, or response, variable,
and the variable or variables being used to predict the value of the dependent variable
are called the independent, or predictor, variables. Regression analysis involving one
independent variable and one dependent variable for which the relationship between the
variables is approximated by a straight line is called simple linear regression. Regression
analysis involving two or more independent variables is called multiple regression analy-
sis. In this section we will show how to use regression analysis to develop forecasts for
a time series that has a trend, a seasonal pattern, and both a trend and a seasonal pattern.
We will also show how to use regression analysis to develop forecast models that include
causal variables.
Linear Trend Projection

We now consider forecasting methods that are appropriate for time series that exhibit
trend patterns and show how regression analysis can be used to forecast a time series
with a linear trend. In Section 5.1 we used the bicycle sales time series in Table 5.3
and Figure 5.3 to illustrate a time series with a trend pattern. Let us now use this time
series to illustrate how regression analysis can be used to forecast a time series with
a linear trend. Although the time series plot in Figure 5.3 shows some up-and-down
movement over the past ten years, we might agree that the linear trendline shown in
Figure 5.3 provides a reasonable approximation of the long-run movement in the series.
We can use regression analysis to develop such a linear trendline for the bicycle sales
time series.
Because simple linear regression analysis yields the linear relationship between the
independent variable and the dependent variable that minimizes the MSE, we can use this
approach to find a best-fitting line to a set of data that exhibits a linear trend. In finding a
linear trend, the variable to be forecasted (y, the actual value of the time series period t) is
the dependent variable and the trend variable (time period t) is the independent variable.
We will use the following notation for our linear trendline.
y^t 5 b0 1 b1t (5.8)
5.4 Using Regression Analysis for Forecasting 227
where
y^t 5 forecast of sales in period t
t 5 time period
b0 5 the y-intercept of the linear trendline
b1 5 the slope of the linear trendline
In equation (5.8), the time variable begins at t 5 1 corresponding to the first time series
observation (year 1 for the bicycle sales time series) and continues until t 5 n corresponding
to the most recent time series observation (year 10 for the bicycle sales time series). Thus,
for the bicycle sales time series t 5 1 corresponds to the oldest time series value, and t 5 10
corresponds to the most recent year.
Excel can be used to compute the estimated intercept b0 and slope b1. The Excel output
for a regression analysis of the bicycle sales data are provided in Figure 5.15.
We see in this output that the estimated intercept b0 is 20.4 (shown in cell B17) and the
estimated slope b1 is 1.1 (shown in cell B18). Thus
y^t 5 20.4 1 1.1t (5.9)
is the regression equation for the linear trend component for the bicycle sales time series.
The slope of 1.1 in this trend equation indicates that over the past ten years the firm has
experienced an average growth in sales of about 1100 units per year. If we assume that the
past ten-year trend in sales is a good indicator for the future, we can use equation (5.9) to
project the trend component of the time series. For example, substituting t 5 11 into equa-
tion (5.9) yields next year’s trend projection, y^11:
y^11 5 20.4 1 1.1 ( 11 ) 5 32.5
Thus, the linear trend model yields a sales forecast of 32,500 bicycles for the next year.
FIGURE 5.15 EXCEL SIMPLE LINEAR REGRESSION OUTPUT FOR TRENDLINE MODEL FOR BICYCLE
SALES DATA
A B C D E F G H I
1 SUMMARY OUTPUT
2
3 Regression Statistics
4 Multiple R 0.874526167
5 R Square 0.764796016
6 Adjusted R Square 0.735395518
7 Standard Error 1.958953802
8 Observations 10
9
10 ANOVA
11 df SS MS F Significance F
12 Regression 1 99.825 99.825 26.01302932 0.000929509
13 Residual 8 30.7 3.8375
14 Total 9 130.525
15
16 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 99.0% Upper 99.0%
17 Intercept 20.4 1.338220211 15.24412786 3.39989E-07 17.31405866 23.48594134 15.90975286 24.89024714
18 Year 1.1 0.215673715 5.100296983 0.000929509 0.60265552 1.59734448 0.376331148 1.823668852
We can also use the trendline to forecast sales farther into the future. Using equa-
tion (5.9), we develop annual forecasts of bicycle sales for two and three years into the
future as follows:
y^12 5 20.4 1 1.1 ( 12 ) 5 33.6

y^13 5 20.4 1 1.1 ( 13 ) 5 34.7
The forecasted value increases by 1100 bicycles in each year.

Note that in this example we are not using past values of the time series to produce
forecasts, so we can produce a forecast for each period of the time series; that is, k 5 0 in
equations (5.3), (5.4), and (5.5) to calculate the MAE, MSE, or MAPE.
We can also use more complex regression models to fit nonlinear trends. For example,
if we also include t2 and t3 as independent variables in our model, the estimated regression
equation would become
y^t 5 b0 1 b1t 1 b2t2 1 b3t3
This model provides a forecast of a time series with curvilinear characteristics over time.
Another type of regression-based forecasting model occurs whenever all the indepen-
dent variables are previous values of the same time series. For example, if the time series
values are denoted y1, y2, . . . , yn, we might try to find an estimated regression equation
relating yt to the most recent time series values, yt21, yt22, and so on. If we use the actual
values of the time series for the three most recent periods as independent variables, the
estimated regression equation would be
y^t 5 b0 1 b1yt21 1 b2yt22 1 b3yt23

Because autoregressive Regression models such as this in which the independent variables are previous values of
models typically violate the the time series are referred to as autoregressive models.
conditions necessary for
inference in least squares
regression, one must be Seasonality
careful if testing hypotheses
or estimating confidence To the extent that seasonality exists, we need to incorporate it into our forecasting models to
intervals in autoregressive ensure accurate forecasts. We begin the section by considering a seasonal time series with
models. There are special no trend and then discuss how to model seasonality with a linear trend.
methods for constructing
autoregressive models, but
they are beyond the scope Seasonality Without Trend
of this book.
Let us consider again the data from Table 5.5, the number of umbrellas sold at a clothing
store over the past five years. As we see in the time series plot provided in Figure 5.5, the
data do not suggest any long-term trend in sales. In fact, unless you look carefully at the
data, you might conclude that the data follow a horizontal pattern with random fluctuation
and that single exponential smoothing could be used to forecast sales. However, closer
inspection of the time series plot reveals a pattern in the fluctuations. The first and third
quarters have moderate sales, the second quarter the highest sales, and the fourth quarter
tends to be the lowest quarter in terms of sales volume. Thus, we conclude that a quarterly
seasonal pattern is present.
We can model a time series with a seasonal pattern by treating the season as a dummy
variable. As indicated in Chapter 4, categorical variables are data used to categorize
observations of data, and k 2 1 dummy variables are required to model a categorical
variable that has k levels. Thus, we need three dummy variables to model four seasons.
For instance, in the umbrella sales time series, the quarter to which each observation
corresponds is treated as a season; it is a categorical variable with four levels: quarter 1,
quarter 2, quarter 3, and quarter 4. Thus, to model the seasonal effects in the umbrella
time series we need 4 2 1 5 3 dummy variables. The three dummy variables can be
coded as follows:
1 if period t is a quarter 1
Qtr1t 5 e
0 otherwise
Qtr2t 5 e
0 otherwise
Qtr3t 5 e
0 otherwise
Using y^t to denote the forecasted value of sales for period t, the general form of the equation
relating the number of umbrellas sold to the quarter the sales take place follows:
y^t 5 b0 1 b1Qtr1t 1 b2Qtr2t 1 b3Qtr3t (5.10)
Note that the fourth quarter will be denoted by setting all three dummy variables to 0. Table 5.11
shows the umbrella sales time series with the coded values of the dummy variables shown. We
can use a multiple linear regression model to find the values of b0, b1, b2, and b3 that minimize
the sum of squared errors. For this regression model, yt is the dependent variable, and the quar-
terly dummy variables Qtr1t, Qtr2t, and Qtr3t are the independent variables.
Using the data in Table 5.11 and regression analysis, we obtain the following equation:
y^t 5 95.0 1 29.0Qtr1t 1 57.0Qtr2t 1 26.0Qtr3t (5.11)
We can use equation (5.11) to forecast sales of every quarter for next year:
Quarter 1: Sales 5 95.0 1 29.0(1) 1 57.0(0) 1 26.0(0) 5 124
Quarter 2: Sales 5 95.0 1 29.0(0) 1 57.0(1) 1 26.0(0) 5 152
Quarter 3: Sales 5 95.0 1 29.0(0) 1 57.0(0) 1 26.0(1) 5 121
Quarter 4: Sales 5 95.0 1 29.0(0) 1 57.0(0) 1 26.0(0) 5 95
TABLE 5.11 UMBRELLA SALES TIME SERIES WITH DUMMY VARIABLES
Period Year Quarter Qtr1 Qtr2 Qtr3 Sales

1 1 1 1 0 0 125
2 2 0 1 0 153
3 3 0 0 1 106
4 4 0 0 0 88
5 2 1 1 0 0 118
6 2 0 1 0 161
7 3 0 0 1 133
8 4 0 0 0 102
9 3 1 1 0 0 138
10 2 0 1 0 144
11 3 0 0 1 113
12 4 0 0 0 80
13 4 1 1 0 0 109
14 2 0 1 0 137
15 3 0 0 1 125
16 4 0 0 0 109
17 5 1 1 0 0 130
18 2 0 1 0 165
19 3 0 0 1 128
20 4 0 0 0 96
It is interesting to note that we could have obtained the quarterly forecasts for next year
by simply computing the average number of umbrellas sold in each quarter. Nonetheless,
for more complex problem situations, such as dealing with a time series that has both trend
and seasonal effects, this simple averaging approach will not work.
Seasonality with Trend

We now consider situations for which the time series contains both seasonal effects and
a linear trend by showing how to forecast the quarterly sales of smartphones introduced
in Section 5.1. The data for the smartphone time series are shown in Table 5.6. The time
series plot in Figure 5.6 indicates that sales are lowest in the second quarter of each year
and increase in quarters 3 and 4. Thus, we conclude that a seasonal pattern exists for smart-
phone sales. However, the time series also has an upward linear trend that will need to be
accounted for in order to develop accurate forecasts of quarterly sales. This is easily done
by combining the dummy variable approach for handling seasonality with the approach for
handling a linear trend discussed earlier in this section.
The general form of the regression equation for modeling both the quarterly seasonal
effects and the linear trend in the smartphone time series is
y^t 5 b0 1 b1Qtr1t 1 b2Qtr2t 1 b3Qtr3t 1 b4t (5.12)
where
y^t 5 forecast of sales in period t
Qtr1t 5 1 if time period t corresponds to the first quarter of the year; 0, otherwise
Qtr2t 5 1 if time period t corresponds to the second quarter of the year; 0, otherwise
Qtr3t 5 1 if time period t corresponds to the third quarter of the year; 0, otherwise
t 5 time period (quarter)
For this regression model yt is the dependent variable and the quarterly dummy variables
Qtr1t , Qtr2t , and Qtr3t and the time period t are the independent variables.
Table 5.12 shows the revised smartphone sales time series that includes the coded
values of the dummy variables and the time period t. Using the data in Table 5.12 with the
regression model that includes both the seasonal and trend components, we obtain the fol-
lowing equation that minimizes our sum of squared errors:
y^t 5 6.07 2 1.36Qtr1t 2 2.03Qtr2t 2 0.304Qtr3t 1 0.146t (5.13)
TABLE 5.12 SMARTPHONE SALES TIME SERIES WITH DUMMY VARIABLES

AND TIME PERIOD
Period Year Quarter Qtr1 Qtr2 Qtr3 Sales (1000s)

1 1 1 1 0 0 4.8
2 2 0 1 0 4.1
3 3 0 0 1 6.0
4 4 0 0 0 6.5
5 2 1 1 0 0 5.8
6 2 0 1 0 5.2
7 3 0 0 1 6.8
8 4 0 0 0 7.4
9 3 1 1 0 0 6.0
10 2 0 1 0 5.6
11 3 0 0 1 7.5
12 4 0 0 0 7.8
13 4 1 1 0 0 6.3
14 2 0 1 0 5.9
15 3 0 0 1 8.0
16 4 0 0 0 8.4
We can now use equation (5.13) to forecast quarterly sales for next year. Next year is year
5 for the smartphone sales time series, that is, time periods 17, 18, 19, and 20.
Forecast for time period 17 (quarter 1 in year 5)
y^17 5 6.07 2 1.36(1) 2 2.03(0) 2 0.304(0) 1 0.146(17) 5 7.19
y^18 5 6.07 2 1.36(0) 2 2.03(1) 2 0.304(0) 1 0.146(18) 5 6.67
y^19 5 6.07 2 1.36(0) 2 2.03(0) 2 0.304(1) 1 0.146(19) 5 8.54
y^20 5 6.07 2 1.36(0) 2 2.03(0) 2 0.304(0) 1 0.146(20) 5 8.99
Thus, accounting for the seasonal effects and the linear trend in smartphone sales, the esti-
mates of quarterly sales in year 5 are 7190, 6670, 8540, and 8990.
The dummy variables in the equation actually provide four equations, one for each quar-
ter. For instance, if time period t corresponds to quarter 1, the estimate of quarterly sales is
Quarter 1: Sales 5 6.07 2 1.36(1) 2 2.03(0) 2 0.304(0) 1 0.146t 5 4.71 1 0.146t
Similarly, if time period t corresponds to quarters 2, 3, and 4, the estimates of quarterly
sales are:
Quarter 2: Sales 5 6.07 2 1.36(0) 2 2.03(1) 2 0.304(0) 1 0.146t 5 4.04 1 0.146t
Quarter 3: Sales 5 6.07 2 1.36(0) 2 2.03(0) 2 0.304(1) 1 0.146t 5 5.77 1 0.146t
Quarter 4: Sales 5 6.07 2 1.36(0) 2 2.03(0) 2 0.304(0) 1 0.146t 5 6.07 1 0.146t
The slope of the trendline for each quarterly forecast equation is 0.146, indicating a con-
sistent growth in sales of about 146 phones per quarter. The only difference in the four
equations is that they have different intercepts.
In the smartphone sales example, we showed how dummy variables can be used to ac-
count for the quarterly seasonal effects in the time series. Because there were four levels for
the categorical variable season, three dummy variables were required. However, many busi-
nesses use monthly rather than quarterly forecasts. For monthly data, season is a categorical
variable with 12 levels, and thus 12 2 1 5 11 dummy variables are required to capture
monthly seasonal effects. For example, the 11 dummy variables could be coded as follows:
1 if period t is January
Month1t 5 e
0 otherwise
1 if period t is February
Month2t 5 e
0 otherwise
(
1 if period t is November
Month11t 5 e
0 otherwise
Other than this change, the approach for handling seasonality remains the same. Time series
data collected at other intervals can be handled in a similar manner.
Using Regression Analysis as a Causal

Forecasting Method
The methods discussed for estimating linear trends and seasonal effects make use of pat-
terns in historical values of the variable to be forecast; these methods are classified as
time series methods because they rely on past values of the variable to be forecast when
developing the model. However, the relationship of the variable to be forecast with other
variables may also be used to develop a forecasting model. Generally such models include
only variables that are believed to cause changes in the variable to be forecast, such as
●
Advertising expenditures when sales is to be forecast.
●
The mortgage rate when new housing construction is to be forecast.
●
Grade point average when starting salaries for recent college graduates is to be
forecast.
●
The price of a product when the demand of the product is to be forecast.
●
The value of the Dow Jones Industrial Average when the value of an individual
stock is to be forecast.
●
Daily high temperature when electricity usage is to be forecast.
Because these variables are used as independent variables when we believe they cause
changes in the value of the dependent variable, forecasting models that include such vari-
ables as independent variables are referred to as causal models. It is important to note here
that the forecasting model provides evidence only of association between an independent
variable and the variable to be forecast. The model does not provide evidence of a causal
relationship between an independent variable and the variable to be forecast, and the con-
clusion that a causal relationship exists must be based on practical experience.
To illustrate how regression analysis is used as a causal forecasting method, we con-
sider the sales forecasting problem faced by Armand’s Pizza Parlors, a chain of Italian res-
taurants doing business in a five-state area. Historically, the most successful locations have
been near college campuses. The managers believe that quarterly sales for these restaurants
(denoted by y) are related positively to the size of the student population (denoted by x);
that is, restaurants near campuses with a large population tend to generate more sales than
those located near campuses with a small population.
Using regression analysis we can develop an equation showing how the dependent vari-
able y is related to the independent variable x. This equation can then be used to forecast
quarterly sales for restaurants located near college campuses given the size of the student
population. This is particularly helpful for forecasting sales of new restaurant locations.
For instance, suppose that management wants to forecast sales for a new restaurant that it
is considering opening near a college campus. Because no historical data are available on
sales for a new restaurant, Armand’s cannot use time series data to develop the forecast.
However, as we will now illustrate, regression analysis can still be used to forecast quarterly
sales for this new location.
To develop the equation relating quarterly sales to the size of the student popula-
tion, Armand’s collected data from a sample of ten of its restaurants located near college
campuses. These data are summarized in Table 5.13. For example, restaurant 1, with
y 5 58 and x 5 2, had $58,000 in quarterly sales and is located near a campus with 2000
students. Figure 5.16 shows a scatter chart of the data presented in Table 5.13, with the
size of the student population is shown on the horizontal axis and quarterly sales shown
on the vertical axis.
What preliminary conclusions can we draw from Figure 5.16? Sales appear to be higher
at locations near campuses with larger student populations. Also, it appears that the relation-
ship between the two variables can be approximated by a straight line. In Figure 5.17 we
can draw a straight line through the data that appears to provide a good linear approxima-
tion of the relationship between the variables. Observe that the relationship is not perfect.
Indeed, few, if any, of the data fall exactly on the line. However, if we can develop the
mathematical expression for this line, we may be able to use it to forecast the value of y
corresponding to each possible value of x. The resulting equation of the line is called the
estimated regression equation.
TABLE 5.13 STUDENT POPULATION AND QUARTERLY SALES DATA FOR TEN
ARMAND’S PIZZA PARLORS
Restaurant Student Population (1000s) Quarterly Sales ($1000s)

1 2 58
2 6 105
3 8 88
WEB file 4
5
8
12
118
117
6 16 137
Armand’s 7 20 157
8 20 169
9 22 149
10 26 202
FIGURE 5.16 SCATTER CHART OF STUDENT POPULATION AND QUARTERLY

SALES FOR ARMAND’S PIZZA PARLORS
220
200
180
Quarterly Sales ($1000s) - y
160
140
120
100
80
60
40
20
0 2 4 6 8 10 12 14 16 18 20 22 24 26
Student Population (1000s) - x
Using the least-squares method of estimation, the estimated regression equation is

yî 5 b0 1 b1xi (5.14)
where
yî 5 estimated value of the dependent variable (quarterly sales) for the ith observation
b0 5 intercept of the estimated regression equation
b1 5 slope of the estimated regression equation
xi 5 value of the independent variable (student population) for the ith observation
FIGURE 5.17 GRAPH OF THE ESTIMATED REGRESSION EQUATION FOR AR-

MAND’S PIZZA PARLORS: y 5 60 1 5x
220
200
180
Quarterly Sales ($1000s) - y
160
5x
140 0+
^y =6
120 Slope b1 = 5
100
80
y intercept 60
b0 = 60 40
20
0 2 4 6 8 10 12 14 16 18 20 22 24 26
Student Population (1000s) - x
The Excel output for a simple linear regression analysis of the Armand’s Pizza data is
provided in Figure 5.18.
We see in this output that the estimated intercept b0 is 60 and the estimated slope b1
is 5. Thus, the estimated regression equation is
yî 5 60 1 5xi
Note that the values of the The slope of the estimated regression equation (b1 5 5) is positive, implying that, as student
independent variable range population increases, quarterly sales increase. In fact, we can conclude (because sales are
from 2000 to 26,000; thus, measured in thousands of dollars and student population in thousands) that an increase in
as discussed in Chapter 4,
the y-intercept in such the student population of 1000 is associated with an increase of $5000 in expected quar-
cases is an extrapolation terly sales; that is, quarterly sales are expected to increase by $5 per student. The estimated
of the regression line and y-intercept b0 tells us that if the student population for the location of an Armand’s pizza
must be interpreted with parlor was 0 students, we would expect sales of $60,000.
caution.
If we believe that the least squares estimated regression equation adequately describes the
relationship between x and y, using the estimated regression equation to forecast the value of y
for a given value of x seems reasonable. For example, if we wanted to forecast quarterly sales
for a new restaurant to be located near a campus with 16,000 students, we would compute
y^ 5 60 1 5 ( 16 )
5 140
Hence, we would forecast quarterly sales of $140,000.

The sales forecasting problem facing Armand’s Pizza Parlors illustrates how simple lin-
ear regression analysis can be used to develop forecasts when a causal variable is available.
FIGURE 5.18 EXCEL SIMPLE LINEAR REGRESSION OUTPUT FOR ARMAND’S PIZZA PARLORS
A B C D E F G H I
1 SUMMARY OUTPUT
2
3 Regression Statistics
4 Multiple R 0.950122955
5 R Square 0.90273363
6 Adjusted R Square 0.890575334
7 Standard Error 13.82931669
8 Observations 10
9
10 ANOVA
11 df SS MS F Significance F
12 Regression 1 14200 14200 74.24836601 2.54887E-05
13 Residual 8 1530 191.25
14 Total 9 15730
15
16 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 99.0% Upper 99.0%
17 Intercept 60 9.22603481 6.503335532 0.000187444 38.72472558 81.27527442 29.04307968 90.95692032
18 Student Population (1,000s) 5 0.580265238 8.616749156 2.54887E-05 3.661905962 6.338094038 3.052985371 6.947014629
Refer to Section 4 of
Chapter 4 for instructions
on how to use Excel’s
Regression or to the Combining Causal Variables with Trend
Chapter 4 appendix for
instructions on how to
and Seasonality Effects
use XLMiner to estimate Regression models are very flexible and can incorporate both causal variables and time
regression models. series effects. Suppose we had a time series of several years of quarterly sales data and
advertising expenditures for a single Armand’s restaurant. If we suspected that sales
were related to the causal variable advertising expenditures and that sales showed trend
and seasonal effects, we could incorporate each into a single model by combining the
The value of an indepen-
dent variable from the prior approaches we have outlined. If we believe the effect of advertising is not immediate,
period is referred to as a we might also try to find a relationship between sales in period t and advertising in the
lagged variable. previous period, t 2 1.
Multiple regression analysis also can be applied in these situations if additional data for
other independent variables are available. For example, suppose that the management of
Armand’s Pizza Parlors also believes that the number of competitors near the college cam-
pus is related to quarterly sales. Intuitively, management believes that restaurants located
near campuses with fewer competitors generate more sales revenue than those located near
campuses with more competitors. With additional data, multiple regression analysis could
be used to develop an equation relating quarterly sales to the size of the student population
and the number of competitors.
Considerations in Using Regression in Forecasting

Although regression analysis allows for the estimation of complex forecasting mod-
els, we must be cautious about using such models and guard against the potential for
overfitting our model to the sample data. Spyros Makridakis, a noted forecasting ex-
pert, conducted research showing that simple techniques usually outperform more com-
plex procedures for short-term forecasting. Using a more sophisticated and expensive
procedure will not guarantee better forecasts. However, many research studies, including
those done by Makridakis, have also shown that quantitative forecasting models such
as those presented in this chapter commonly outperform qualitative forecasts made by
“experts.” Thus, there is good reason to use quantitative forecasting methods whenever
data are available.
Whether a regression approach provides a good forecast depends largely on how well
we are able to identify and obtain data for independent variables that are closely related to
the time series. Generally, during the development of an estimated regression equation, we
will want to consider many possible sets of independent variables. Thus, part of the regres-
sion analysis procedure should focus on the selection of the set of independent variables
that provides the best forecasting model.
NOTES AND COMMENTS
Several other methods for estimating trend and methods treat the effects as multiplicative (that
seasonal effects exist. These include but are not is, seasonal effects are more pronounced when
limited to Holt-Winters seasonal smoothing and the trend effect is large). We refer students who
Holt-Winters multiplicative method. Although are interested in these and other more advanced
each of the methods we have considered treats methods for time series analysis to the references
the trend and seasonal effects (and the cyclical listed at the end of this textbook.
effect, if included in the model) as additive, some
5.5 Determining the Best Forecasting

Model to Use
Given the variety of forecasting models and approaches, the obvious question is, “For
a given forecasting study, how does one choose an appropriate model?” As discussed
throughout this text, it is always a good idea to get descriptive statistics on the data and
graph the data so that it can be visually inspected. In the case of times series data, a visual
inspection can indicate whether seasonality appears to be a factor and whether a linear or
nonlinear trend seems to exist. For causal modeling, scatter charts can indicate whether
strong linear or nonlinear relationships exist between the independent and dependent vari-
ables. If certain relationships appear totally random, this may lead you to exclude these
variables from the model.
As in regression analysis, you may be working with large data sets when generating
a forecasting model. In such cases, it is recommended to divide your data into training
and validation sets. For example, you might have five years of monthly data available
to produce a time series forecast. You could use the first three years of data as a training
set to estimate a model or a collection of models that appear to provide good forecasts.
You might develop exponential smoothing models and regression models for the train-
ing set. You could then use the last two years as a validation set to assess and compare
the models’ performances. Based on the errors produced by the different models for
the validation set, you could ultimately pick the model that minimizes some forecast
error measure, such as MAE, MSE or MAPE. However, you must exercise caution in
using the older portion of a time series for the training set and the more recent portion
of the time series as the validation set; if the behavior of the time series has changed
recently, the older portion of the time series may no longer show patterns similar to the
Glossary 237
more recent values of the time series, and a forecasting model based on such data will
not perform well.
Some software packages try many different forecasting models on time series data
(those included in this chapter and more) and report back optimal model parameters and
error measures for each model tested. Although some of these software packages will even
automatically select the best model to use, ultimately the user should decide which model
to use going forward based on a combination of the software output and the user’s manage-
rial knowledge.
Summary
This chapter provided an introduction to the basic methods of time series analysis and fore-
casting. First, we showed that to explain the behavior of a time series, it is often helpful to
graph the time series and identify whether trend, seasonal, and/or cyclical components are
present in the time series. The methods we have discussed are based on assumptions about
which of these components are present in the time series.
We discussed how smoothing methods can be used to forecast a time series that exhibits
no significant trend, seasonal, or cyclical effect. The moving averages approach consists of
computing an average of past data values and then using that average as the forecast for the
next period. In the exponential smoothing method, a weighted average of past time series
values is used to compute a forecast.
For time series that have only a long-term trend, we showed how regression analysis
could be used to make trend projections. For time series with seasonal influences, we showed
how to incorporate the seasonality for more accurate forecasts. We described how regression
analysis can be used to develop causal forecasting models that relate values of the variable
to be forecast (the dependent variable) to other independent variables that are believed to
explain (cause) the behavior of the dependent variable. Finally, we have provided guidance
on how to select an appropriate model from the models discussed in this chapter.
Glossary
Forecast A prediction of future values of a time series.

Time series A set of observations on a variable measured at successive points in time or
over successive periods of time.
Stationary time series A time series whose statistical properties are independent of time.
Trend The long-run shift or movement in the time series observable over several periods
of time.
Seasonal pattern The component of the time series that shows a periodic pattern over one
year or less.
Cyclical pattern The component of the time series that results in periodic above-trend and
below-trend behavior of the time series lasting more than one year.
Forecast error The amount by which the forecasted value y^t differs from the observed
value yt and y^t, denoted et 5 yt 2 y^t.
Mean absolute error (MAE) A measure of forecasting accuracy; the average of the values
of the forecast errors.
Mean squared error (MSE) A measure of the accuracy of a forecasting method; this
measure is the average of the sum of the squared differences between the forecast values
and the actual time series values.

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Analytics in Action 203

NOTES AND COMMENTS

5.1 Time Series Patterns

TABLE 5.1 GASOLINE SALES TIME SERIES

FIGURE 5.1 GASOLINE SALES TIME SERIES PLOT

Sales (1000s of gallons)

© Cengage Learning 2015

TABLE 5.2 GASOLINE SALES TIME SERIES AFTER OBTAINING THE

changes in the level of a time series is an important consideration in many practical

TABLE 5.3 BICYCLE SALES TIME SERIES

Year Sales (1000s)

FIGURE 5.3 BICYCLE SALES TIME SERIES PLOT

TABLE 5.4 CHOLESTEROL DRUG REVENUE TIME SERIES

Year Revenue ($ millions)

FIGURE 5.4 CHOLESTEROL DRUG REVENUE TIMES SERIES PLOT ($ MILLIONS)

Trend and Seasonal Pattern

TABLE 5.5 UMBRELLA SALES TIME SERIES

Year Quarter Sales

FIGURE 5.5 UMBRELLA SALES TIME SERIES PLOT

TABLE 5.6 QUARTERLY SMARTPHONE SALES TIME SERIES

Year Quarter Sales ($1000s)

FIGURE 5.6 QUARTERLY SMARTPHONE SALES TIME SERIES PLOT

Identifying Time Series Patterns

5.2 Forecast Accuracy

Time Absolute Value Squared Absolute Value

Forecast Error in week 2 5 e2 5 y2 2 y^2 5 21 2 17 5 4

MEAN FORECAST ERROR (MFE)

MEAN ABSOLUTE ERROR (MAE)

MEAN SQUARED ERROR (MSE)

monthly gasoline sales to a method of forecasting weekly sales) or to make comparisons

MEAN ABSOLUTE PERCENTAGE ERROR (MAPE)

Time Absolute Value Squared Absolute Value

Naïve Method Average of Past Values

Measures of forecast accuracy are important factors in comparing different forecast-

5.3 Moving Averages and Exponential Smoothing

MOVING AVERAGE FORECAST

a ( most recent k data values ) i5t2k11

TABLE 5.9 SUMMARY OF THREE-WEEK MOVING AVERAGE CALCULATIONS

Time Absolute Value Squared Absolute Value

FIGURE 5.7 GASOLINE SALES TIME SERIES PLOT AND THREE-WEEK

Sales (1000s of gallons) 20

FIGURE 5.8 DATA ANALYSIS DIALOG BOX

FIGURE 5.9 MOVING AVERAGE DIALOG BOX

FIGURE 5.10 EXCEL OUTPUT FOR MOVING AVERAGE FORECAST FOR

EXPONENTIAL SMOOTHING FORECAST:

TABLE 5.10 SUMMARY OF THE EXPONENTIAL SMOOTHING FORECASTS

Time Series Forecast Squared Forecast

FIGURE 5.11 ACTUAL AND FORECAST GASOLINE TIME SERIES WITH

FIGURE 5.12 DATA ANALYSIS DIALOG BOX

FIGURE 5.13 EXPONENTIAL SMOOTHING DIALOG BOX

FIGURE 5.14 EXCEL OUTPUT FOR EXPONENTIAL SMOOTHING FORECAST

NOTES AND COMMENTS

5.4 Using Regression Analysis for Forecasting

Linear Trend Projection

y^12 5 20.4 1 1.1 ( 12 ) 5 33.6

The forecasted value increases by 1100 bicycles in each year.

y^t 5 b0 1 b1t 1 b2t2 1 b3t3

y^t 5 b0 1 b1yt21 1 b2yt22 1 b3yt23

TABLE 5.11 UMBRELLA SALES TIME SERIES WITH DUMMY VARIABLES

Period Year Quarter Qtr1 Qtr2 Qtr3 Sales

Seasonality with Trend

TABLE 5.12 SMARTPHONE SALES TIME SERIES WITH DUMMY VARIABLES

Period Year Quarter Qtr1 Qtr2 Qtr3 Sales (1000s)