Lecture 7 Time Series Analysis Time Series: A set of numerical data that is obtained at regular periods over time

or A collection of data observed or recorded at regular intervals of time each hour, day, month, quarter or year is called a time series, e.g. the monthly total of passengers carried by rail, daily closing prices of a particular stock on the New York Stock Exchange constitutes a time series, etc. Time series may consist of weekly production output, monthly sales, annual rainfall, or any other variable for which the value is observed at regular intervals. Time series is examined for two reasons: (a) to understand the past, and (b) to predict the future value. Components of time series Analysis of time series involves identifying the components that have led to the fluctuations in the data. There are four basic types of movements for time series: 1. Trend Component or Secular trend (T) 2. Cyclical component or cyclical fluctuation (C) 3. Seasonal component or seasonal variation (S) 4. Irregular component or random variation (I) The model assumes that any observed value of y is the result of multiplicative influences exerted by the four components. The observed value y is assumed to be the trend value, T, by the combined influence of the cyclical, seasonal, and irregular components. Trend component (T): A secular trend is a long-term upward or downward pattern of movement that persists for not less than 10 years, e.g. sales, prices, industrial production, etc. It also helps in business planning. To the extent that the trend component is present, a regression line fitted to the points on the time series plot will have either a positive or negative slope. Reason for Influence: Changes in technology, population, wealth, value, etc

Instructor: Azmat Nafees

QTM

23-Oct-11

Cyclical component (C): The so-called business cycles which represent repeating up called up-and-down swings or movements through four phases of business: from peak (prosperity) to contraction (recession) to trough (depression) to expansion (recovery or growth), within 2 10 years with dif differing intensity for a complete cycle. Reason for Influence: Interaction of numerous combinations of factors influencing the economy.

Seasonal component (S): Fairly regular short term periodic fluctuations that occur within each 12 12-month period year after year (monthly or quarterly data), e.g. the sales of soft drinks which are high in the summer low in the winter. Reason for Influence: Weather conditions, social customs, religious customs, etc.

Irregular component (I): The residual fluctuations in a time series that exist after taking into account the exist systematic effects trend, seasonal, and cyclical. These variations occur in completely unpredictable manner for short duration and non-repeating and also called accidental variations. repeating Reason for Influence: Random variations in data or due to unforeseen events such as strikes, hurricanes, events floods, war, political assassinations, etc.

Instructor: Azmat Nafees

QTM

23-Oct-11 11

Method of moving averages It is the estimate of the long-run average of the variable. It is computed by averaging the observations over a certain number of time periods. The same number of time periods is used in each successive average. The purpose of Moving Averages i. To smooth out large variations ii. To take away the short-term seasonal and irregular variations Ratio to moving average method The effect of seasonal fluctuations is quantified by using a technique called the ratio to moving average method. This method can be explained by using an example: Example: YearQuarters 1994-I 1994-II 1994-III 1994-IV 1995-I 1995-II 1995-III 1995-IV 1996-I 1996-II 1996-III 1996-IV YEARS 1994 1995 1996 Actual value (Yt) 500 350 250 400 450 350 200 300 350 200 150 400 4-QTR Centered moving (TC) * * 368.75 362.50 356.25 337.50 312.50 281.25 256.25 262.50 * * SI = Yt / TC * * 0.67797 1.10345 1.26316 1.03704 0.64000 1.06667 1.36585 0.76190 * * Adjusted SI 1.3284 0.9090 0.6660 1.0966 1.3284 0.9090 0.6660 1.0966 1.3284 0.9090 0.6660 1.0966 Total

I * 1.26316 1.36585

Quarters II III * 1.03704 0.7619 0.8995 0.909 0.67797 0.64 * 0.659 0.666

IV 1.10345 1.06667 * 1.0851 1.0966

MEAN 1.3145 (Unadjusted) **Adjusted 1.3284 SI ** Adjusted SI = .

3.958 4.000

Deseasonalizing the time series Finding and eliminating the seasonal variation is known as deseasonalizing of the time series. We remove the influence of seasonal variations and generate time series that is said to be seasonally adjusted. We can compute deseasonlized values by (Actual value) / (Adjusted SI)

Instructor: Azmat Nafees

QTM

23-Oct-11

Example: YearQuarters 1994-I 1994-II 1994-III 1994-IV 1995-I 1995-II 1995-III 1995-IV 1996-I 1996-II 1996-III 1996-IV Actual value (Yt) 500 350 250 400 450 350 200 300 350 200 150 400 Adjusted SI 1.3284 0.9090 0.6660 1.0966 1.3284 0.9090 0.6660 1.0966 1.3284 0.9090 0.6660 1.0966 Deseasonalized values 376.39 385.04 375.38 364.76 338.75 385.04 300.30 273.57 263.48 220.02 225.23 364.76

Trend Analysis In fitting a trend line with regression techniques, the line may be linear or nonlinear, where is the trend line estimate for y and x = time. There are two types of trends that we can fit for time series: 1. Linear Trends (Straight Line) 2. Nonlinear Trends (Polynomial and Exponential) We study trend 1) To describe a historical pattern, 2) To eliminate the trend components firm the series 3) For predictive purposes, (i.e. to make intermediate & long-range forecasting) 4) In order to isolate and then eliminate its influencing effects on the time series model (i.e. a short-run (1 year or less) forecasting of business cycle)

Fitting Linear Trend: In this model, a least squares linear equation is fitted to the set of observed data points. It can be summarized as The linear trend equation: = + Where is the trend line estimate and x is the time period Instructor: Azmat Nafees QTM 23-Oct-11 4

Example: Shown below are the net sales for the J. M. Smucker Company, a leading marketer of jams and jellies for 14 years (1990 2003):
Time Series Plot of Sales (Millions)
700

600 Sales (Millions)

500

400

300 1 2 3 4 5 6 7 8 Years 9 10 11 12 13 14

Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Sales (millions) 345 399 425 454 462 478 511 529 524 565 602 632 651 687

The following graph shows the original time series and fitted trend:
Trend Analysis Plot for Sales (Millions)
Linear Trend Model Yt = 341.03 + 23.7*t 700

600 Sales (Millions)

500

400

300 1 2 3 4 5 6 7 8 Years 9 10 11 12 13 14

Forecasting Methods There are many forecasting methods that can be used to predict future events. These methods can be divided into two basic types: Qualitative methods and Quantitative methods. In Quantitative methods we have discussed here only Forecasting by Trend and Forecasting by Exponential Smoothing. Forecasting by Trend In above example, the forecasted sales for 2004 can be estimated as: Sales = 341.03 + 23.7 (15) = $696.53 millions

Instructor: Azmat Nafees

QTM

23-Oct-11

Exponential Smoothing is a procedure for continually revising a forecast in the light of more recent experience. Exponential Smoothing is a popular and relatively simple technique to smooth out the random variations in time series. In this method, each smoothed value is a weighted average of current and past values. The exponential smoothing of a time series can be given as: = + (1 ) Where Et = the exponentially smoothed value for time period t Et-1 = the exponentially smoothed value for the previous time period Yt = the actual value in the time series for time period t = the smoothing constant, and 0 1 Initial values are to be set first before computing exponentially smoothed value for each time period. The initial value for E1 can be set as Y1. Smoothing Constant: The smoothing constant serves as the weighting factor. The actual value of determines the extent to which the current observation is to influence the forecast value. If it is desired that prediction be stable and random variations smoothed, a small value of is required. The curve with smaller smoothing constant can be more strongly smoothed out the fluctuations in the original time series. Forecasting: Another general expression for exponential smoothing can be given as: New forecast = [ (New observation)] + [(1 ) (Old forecast)] More formally, the exponential smoothing equation is = + (1 ) Where = the exponentially smoothed value for time period t = the exponentially smoothed value for the previous time period Yt = the actual value in the time series for time period t = the smoothing constant, and 0 1 The initial value for can be set as Y1.

Instructor: Azmat Nafees

QTM

23-Oct-11

Example 1: Cedar Fair operates seven amusement parks and five separately gated water parks. Its combined attendance (in thousands) for the last 8 years is given in the following table. A partner asks you to study the trend in attendance. Fit an exponentially smoothed curve with smoothing constant = 0.2; with smoothing constant = 0.6. Which constant provides more smoothing and why?
= 0.2 = 0.6

Year 2000 2001 2002 2003 2004 2005 2006 2007

Attendance (000) 11,703 11,890 12,380 12,181 12,557 12,700 19,300 22,100
11703.0 11740.4 11868.3 11930.9 12056.1 12184.9 13607.9 15306.3 11703.0 11703.0 11740.4 11868.3 11930.9 12056.1 12184.9 13607.9 11703.0 11815.2 12154.1 12170.2 12402.3 12580.9 16612.4 19904.9 11703.0 11703.0 11815.2 12154.1 12170.2 12402.3 12580.9 16612.4

The initial value is set as E1 = Y1 = 11,703. When we take = 0.2, then = (0.2) + (0.8) = (0.2)(11,890) + (0.8) (11,703) = 11,740.4 And = (0.2) + (0.8) = (0.2)(11,703) + (0.8) (11,703) = 11,703 When we take = 0.6, then = (0.6) + (0.4) And = (0.6) + (0.4)

= (0.6)(11,890) + (0.4) (11,703) = 11,740.4 = (0.6)(11,703) + (0.4) (11,703) = 11,703

The smoothing constant 0.2 provides more smoothing values than 0.6. The larger smoothing constant gives more close values to actual values.

Instructor: Azmat Nafees

QTM

23-Oct-11