Chapter 2 Understanding Time Series Student PDF

Chapter 2: Understanding Time Series
Chapter 2:
2.1
Understanding Time Series
Definition of Time Series

A chronological sequence of observations on a particular variable
In other words, a set of data collected or arranged in a sequence of order
over a successive equal increment of time
2.2
Component of Time Series

The four components of a time series are
Trend, Tt
Cycle, Ct
Seasonal variations, St
Irregular fluctuations, It
Relationship between components
Multiplicative effect
Size of seasonal variation increase in accordance with the increase
in the level of the data series
The time series exhibits increasing or decreasing seasonal variation
Multiplicative model
yt Tt Ct St I t
700
600
Output
500
400
300
200
100
0
1
1
1
6
1 2
11
1 2
16
1 2
21
1 2
26
Time
Additive effect
Absolute sizes of the seasonal variation are independent of each
other
The time series exhibits constant seasonal variation
Additive model
yt Tt Ct St I t
SQQS 3033 Business Forecasting
30000
25000
20000
15000
10000
5000
0
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
2.2.1 The Trend Component

Upward (positive) or downward (negative) movement that characterizes a
time series over a period of time
Reflects the long-run growth or decline
Data are considered stationary when there is neither a positive nor a
negative trend
Example
60
120
50
100
40
80
30
60
20
40
10
20
0
1
10 11 12 13 14 15 16 17
-10
0
1
Linear trend
10 11 12 13 14 15 16 17
Exponential trend
Main reasons for studying the trend pattern

To allow the modeler to understand the historical pattern existing in
the time series
Understanding of the trend pattern enables the forecaster to determine
suitable model
To enable the modeler to project past pattern or trend into future for
forecasting purposes
To enable the modeler to isolate or remove the trend component from
the actual data
2.2.2 The Cyclical Component

Recurring up and down movements around the long-run trend over
unspecific period of time
Common cyclical fluctuations found in time series data is the business
cycle
Example
2.2.3 The Seasonal Component

Regular fluctuations occurring within a specific period of time
In other words, periodic patterns or regular variation that complete
themselves within a calendar year and then repeated on a yearly basis
Ordinarily, monthly or quarterly data are used to examine seasonal
variations
Example
Main reasons for studying the seasonal fluctuation

Seasonality is the second most prominent component of time series
data can mask cyclical movements and cyclical turning points
In short-term perspective, understanding seasonal changes can
dramatically improve the forecast accuracy
For long-term planning, knowing the product that have distinctly
different seasonal pattern would enable the company to allocate their
resources and materials for production in more appropriate manner
Remove seasonal component has the advantage that the occurrences of
the fluctuations reflect the true movements of the series
2.2.4 The Irregular Component

Also referred as random effect
Erratic movements that follow no recognizable and regular pattern
Caused by unusual events that cannot be forecasted
2.3
Estimate the Trend Component
2.3.1 Linear Trend Line

General linear trend pattern
Tt t t
Use ordinary least squares (OLS) method to estimate and
Minimize the sum of squared of the differences between the actual and
the estimated values
t
SS
t y
ty where SS ty ty and SStt t 2
n
n
SS tt
y t where y
y
n
and t
t
n
Example 1
A saving institution handles savings accounts and makes loans to members. In
order to plan its investment strategies, it requires the predictions of monthly
loan requests to be made by its members in future months. Monthly loan
requests for its last year operation are recorded in the following table.
Month
January
February
March
April
May
June
July
August
September
October
November
December
Loan requests (in RM 1000)

297
249
340
406
464
481
549
553
556
642
670
712
Solution
Loan request
800
600
400
200
0
0
6 7
Time
9 10 11 12
2.3.2 Moving Average and Centered Moving Average

Assumption: data pattern can be best represented by arithmetic mean of
the past observation
1
Equal weights of
are assigned to each of the n observations used in the
n
calculations of moving average.
y y2 y3
If n = 3, M1 1
3
y1 y2 y3 y4
If n = 4, M1
4
Odd number of n
The moving average, M is easily placed at the centre of the affected
time periods
Mt
Time (t)
1
yt
y2
M1
y3
M2
y4
M3
y5
M4
y6
y1
y1 y2 y3
3
y2 y3 y4
3
y3 y4 y5
3
y4 y5 y6
3
-
Even number of n
The moving average, M cannot be placed on the graph.
Requires centering process to find the centered moving average,
CM
Centered moving average, CM is the two-period moving average of
the computed moving average, M
Time (t)
1
2
yt
Mt
CM t
y1
y2
y3
y4
M M2
CM 1 1
2
M M3
CM 2 2
2
y5
y6
y y2 y3 y4
M1 1
4
y y3 y4 y5
M2 2
4
y y4 y5 y6
M3 3
4
-
Revise the average as new observation become available

The more observations are included in calculation of the averages, the
smoother will be the moving average line obtained, and however, the more
data points are lost.
Difficult when extrapolating beyond sample data points to generate the
forecast values
Used to eliminate seasonal variation and irregular fluctuations from the
data
Example 2
Compute 3-period, 4-period moving average and the centered moving average
for the data given in Example 1.
Solution
3-period moving average
t
Mt
yt
297
249
340
406
464
481
549
553
556
642
670
712
1
2
3
4
5
6
7
8
9
10
11
12
4-period moving average and centered moving average

t
1
2
3
4
5
6
7
8
9
10
11
12
yt
297
249
340
406
464
481
549
553
556
642
670
712
Mt
CM t
2.3.3 Irregularities in Trend Estimation and Identification

Three situations may arise
Major turning point
The point in the series where the trend changes its direction.
The change in direction should continue over a significance
amount of time.
The occurrence of a major isolated or random shock
Affects the trend and later returns to the normal level.
Two categories short-term memory effect or long-term memory
effect.
Short-term memory effect, the level returns to normal within a
short period of time.
Long-term memory effect, the level may take a longer period of
time before returning to its normal level.
Incidence of an outlier
Outlier extremely large or small values
It presence significantly affects the trend.
Easy way to eliminate the potential effect by taking the average of
the values in the period within its vicinity results in loss of vital
information pertaining to the series being investigated.
2.4
Identifying Cyclical Component

There are two simple methods that can be used to identify cyclical
variation
The residual method
The relative cyclical residual method
2.4.1 The Residual Method

Cyclical variation defined in terms of the percentage of trend
y
Percentage of trend t 100
Tt
where yt = actual value in period t
Tt = estimated trend value in period t
Less than 100 recession
Greater than 100 expanding
2.4.2 The Relative Cyclical Residual Method

Find the percentage deviation from the trend for each period
y T
Relative Cyclical Residual t t 100
Tt
where yt = actual value in period t

Tt = estimated trend value in period t
Negative value recession
Positive value expanding
Example 3
Identify the cyclical characteristic of the following data using residual method
and relative cyclical residual method.
Consumer
Price Index
47.5
49.7
51.1
53.5
55.9
57.8
61.8
67.8
71.7
74.4
77.0
77.3
Years
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
Consumer
Price Index
77.8
78.4
80.4
82.6
85.2
88.9
93.1
96.4
100.0
103.4
107.0
109.9
Years
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Solution
120
CPI
90
60
30
0
0
10
15
Time
20
yt
Tt
yt
100
T
t
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
yt Tt
100
T
t
47.5
49.7
51.1
53.5
55.9
57.8
61.8
67.8
71.7
74.4
77.0
77.3
77.8
78.4
80.4
82.6
85.2
88.9
93.1
96.4
100.0
103.4
107.0
109.9
10
2.5
Identifying Seasonal Component

There are two methods to identify seasonal component in the data
Seasonal factor - Seasonal ratio or seasonal indices
Method of seasonal differencing (will be discussed in Box-Jenkins
methodology)
Seasonal Factor
Multiplication effect (seasonal ratio)
y
St I t t
CM t
Additive effect
St I t yt CM t
2.6
Decomposition Method
There are 2 decomposition methods, based on the relationship between
time series components.
Multiplicative decomposition method
Additive decomposition method
Steps in decomposition method
Step 1: centered moving average
Compute the centered moving average, CM t
Remove seasonal variations and short-term irregular fluctuations
CM t Tt Ct
or
CM t Tt Ct
Step 2: seasonal component
Compute the seasonal factor based on the relationship of the time
series components
Normalized the seasonal factor to estimate seasonal component
Remove the seasonal component from the data
Step 3: trend component
Estimate the trend component based on the deseasonalized data
Remove the trend component from the deseasonalized data
Step 4: cyclical component
Estimate the cyclical component is the 3-period moving average of
the data
Step 5: irregular component
Remove the cyclical component to estimate the irregular
component
The steps of decomposition will be illustrated using the following example.
The estimated Tt , Ct , St and I t can be use to describe the time series and
forecast future values.
11
2.6.1
Multiplicative Decomposition Method

Example 4
Following is the quarterly sales of a drink recorded for the past four years. Use
suitable decomposition method to forecast the sales for this year.
Year
1
Quarter
1
2
3
4
1
2
3
4
Sales
667
980
2352
1375
859
1239
2943
1737
Year
Quarter
1
2
3
4
1
2
3
4
Sales
1049
1477
3545
2060
1250
1760
4170
2378
Solution
4500
Sales
3000
1500
0
0
12
16
Time
12
yt
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
667
980
2352
1375
859
1239
2943
1737
1049
1477
3545
2060
1250
1760
4170
2378
Mt
CM t
y
St It t
CM t
S t
dt
Tt
Tt St
C t It
yt
Tt St
C t
It
13
14
2.6.2
Additive Decomposition Method

Example 5
Following is the quarterly sales of mountain bike recorded for the past four
years. Use suitable decomposition method to forecast the sales for this year.
Year
1
Quarter
1
2
3
4
1
2
3
4
Sales
10
31
43
16
11
33
45
17
Year
3
Quarter
1
2
3
4
1
2
3
4
Sales
13
34
48
19
15
37
51
21
Solution
60
Sales
45
30
15
0
0
8
Time
12
16
15
yt
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
10
31
43
16
11
33
45
17
13
34
48
19
15
37
51
21
Mt
CM t
St It yt CM t
S t
dt
Tt
Tt St
C t It yt Tt St
C t
It
16

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Understanding Time Series

Definition of Time Series

Component of Time Series

SQQS 3033 Business Forecasting