Time Series and

Forecasting
Chapter 16

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Learning Objectives
LO1 Define the components of a time series
LO2 Compute Moving average, weighted moving average
and exponential smoothing
LO3 Determine a linear trend equation
LO4 Use a trend equation to compute forecasts
LO5 Determine and interpret a set of seasonal indexes
LO6 Deseasonalize data using a seasonal index
LO7 Calculate seasonally adjusted forecasts
LO8 Use a trend equation for a nonlinear trend

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Time Series and its Components
TIME SERIES is a collection of data recorded over a period of time (weekly,
monthly, quarterly), an analysis of history, that can be used by management
to make current decisions and plans based on long-term forecasting. It
usually assumes past pattern to continue into the future

Components of a Time Series

1. Secular Trend – the smooth long term direction of a time series
2. Cyclical Variation – the rise and fall of a time series over periods longer
than one year
3. Seasonal Variation – Patterns of change in a time series within a year
which tends to repeat each year
4. Irregular Variation – classified into:
Episodic – unpredictable but identifiable
Residual – also called chance fluctuation and unidentifiable
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Secular Trend – Examples

16-4
Cyclical Variation – Sample Chart

1991 1996 2001 2006 2011

16-5
Seasonal Variation – Sample Chart

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Irregular variation

 Caused by irregular and unpredictable

changes in a times series that are not
caused by other components
 Exists in almost all time series
 Needs to reduce irregular variation to
make accurate predictions

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The Moving Average Method
 Useful in smoothing time series to see its
trend
 Basic method used in measuring seasonal
fluctuation
 Applicable when time series follows fairly
linear trend that have definite rhythmic
pattern

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Moving Average Method - Constant
duration of cycles

16-9
3-year and 5-Year Moving Averages Data-> Data
Gas Sales Analysis ->
Moving
39 100
Average
37 90
61 80
58
70
18
60
56
Gas Sales
82 50
3-period

27 40
5-period

41 30
69 20
49
10
66
0
54 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
42
90
66

16-10
Moving average method for an
even time period
Year Sales, Y Four-Year Four-Year Centered
Moving Total Moving Four-
average Year
Moving
1995 $8 Average
1996 11
$42(8+11+9+14) $10.50($42/4)
1997 9
43 10.75 10.625
1998 14
42 10.50 10.625
1999 9
43 10.75 10.625
2000 10
37 9.25 10.000
2001 10
40 10.00 9.625
2002 8
2003 2
Weighted Moving Average
 A simple moving average assigns the same
weight to each observation in averaging
 Weighted moving average assigns different
weights to each observation
 Most recent observation receives the most
weight, and the weight decreases for older data
values
 In either case, the sum of the weights = 1

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 Weighted Moving Average - Example
Cedar Fair operates seven amusement parks and
five separately gated water parks. Its combined
attendance (in thousands) for the last 17 years is
given in the following table. A partner asks you to
study the trend in attendance. Compute a three-
year moving average and a three-year weighted
moving average with weights of 0.2, 0.3, and 0.5 for
successive years.

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Weighted Moving Average - Example

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Weighed Moving Average – An Example

16-15
Linear Trend
 The long term trend of many business series often
approximates a straight line


Linear Trend Equation : Y  a  bt
where :

Y  read "Y hat" , is the projected value of the Y
variable for a selected value of t

a  the Y - intercept

b  the slope of the line

t  any value of time (coded) that is selected

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Linear Trend Plot

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Linear Trend – Using the Least Squares
Method
 Use the least squares method in Simple Linear
Regression (Chapter 13) to find the best linear
relationship between 2 variables
 Code time (t) and use it as the independent
variable
 E.g. let t be 1 for the first year, 2 for the second,
and so on (if data are annual)

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Linear Trend – Using the Least Squares
Method: An Example
The sales of Jensen Foods, a small grocery chain located in southwest Texas, since 2005 are:

Sales
Year t ($ mil.)

2005 1 7
2006 2 10
2007 3 9
2008 4 11
2009 5 13
Seasonal Variation
 Fluctuations that coincide with certain seasons;
repeated year after year
 Understanding seasonal fluctuations help plan for
sufficient goods and materials on hand to meet varying
seasonal demand
 Analysis of seasonal fluctuations over a period of years
help in evaluating current sales

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Seasonal Index
 A number, usually expressed in percent, that
expresses the relative value of a season with
respect to the average for the year (100%)
 Ratio-to-moving-average method
 The method most commonly used to compute the
typical seasonal pattern
 It eliminates the trend (T), cyclical (C), and irregular
(I) components from the time series

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 Ratio of
sales to

Bermuda Hotel example Quarter Period t Rate

4-quarter
moving
averages
Centered
moving
averaged
centered
moving
averages
1 1 0.561

Step (1) – Organize time 2 2 0.702 0.65775

series data in column form 3 3 0.800 0.66125 0.6595 1.21304

4 4 0.568 0.67025 0.66575 0.853173
Step (2) Compute the 4-
1 5 0.575 0.68725 0.67875 0.847145
quarter moving totals
2 6 0.738 0.6965 0.691875 1.066667
Step (3) Compute the 4-
3 7 0.868 0.70125 0.698875 1.241996
quarter moving averages
4 8 0.605 0.70125 0.70125 0.862745
Step (4) Compute the 1 9 0.594 0.6665 0.683875 0.86858
centered moving averages 2 10 0.738 0.66525 0.665875 1.108316
by getting the average of 3 11 0.729 0.67225 0.66875 1.090093
two 4-quarter moving 4 12 0.600 0.66475 0.6685 0.897532
averages 1 13 0.622 0.684 0.674375 0.922335
Step (5) Compute ratio by 2 14 0.708 0.692 0.688 1.02907
dividing actual rate by the 3 15 0.806 0.70275 0.697375 1.155763
centered moving averages 4 16 0.632 0.7345 0.718625 0.879457
1 17 0.665 0.75125 0.742875 0.895171
2 18 0.835 0.76075 0.756 1.104497
3 19 0.873
4 20 0.670

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Seasonal Index – An Example

Year 1 2 3 4

2006 1.21304 0.853173

2007 0.847145 1.066667 1.241996 0.862745

2008 0.86858 1.108316 1.090093 0.897532

2009 0.922335 1.02907 1.155763 0.879457

2010 0.895171 1.104497

Average 0.883308 1.077137 1.175223 0.873227

Index 0.883308 1.077137 1.175223 0.873227

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