This lesson begins with background information about forecasting and continues discussing the forecasting process. We concentrate on four main steps: set an objective, build model, evaluate model, and use model.

1. Introduction to Forecasting Lesson #1 Introduction to Forecasting Using quantitative methods Copyright 2010 DeepThought, Inc. 1

3. Universal meaning

4. Widely used in business

6. Build on personal experience

7. No data needed

8. Hard to measureCopyright 2010 DeepThought, Inc. 2

10. Linear regression: Y = a + b × x

11. Exponential smoothing: F(t+1) = a × A(t) + (1-a) × F(t)

12. Moving average, multivariable, etc.

13. Have Multiple Purposes

14. Forecasting

15. Trend, seasonality, and cyclical estimation

16. Evaluating variable relationships

17. And more…Copyright 2010 DeepThought, Inc. 3

19. The central limit theorem states that if a variable has 30 or more observations, we can use the normal distribution approximation to evaluate its mean and variance

20. Enables us to test the statistical significance of the model and its coefficientsCopyright 2010 DeepThought, Inc. 4

22. Each method can answer different questions

23. Some methods should only be used in specific situations

24. Method selection steps:

25. Select dependent variable

26. Select units

27. Select time frame

28. Select what method to use

29. Adjusted units if needed to fit method

30. Adjust how many periods to forecast depending on methodCopyright 2010 DeepThought, Inc. 5

32. Minimizing the sum of squared errors

33. A sum of square difference of actual data points compared to model produced data points

34. Creates the best fit model using that specific forecasting method

35. Model statistics are produced for model evaluateCopyright 2010 DeepThought, Inc. 6

37. The same statistics are used for all type of methods

38. Enables us to compare multiple models to find the best modelsCopyright 2010 DeepThought, Inc. 7

39. Introduction to Forecasting Forecasting Steps Set an objective Build model Evaluate model Use model Copyright 2010 DeepThought, Inc. 8

41. Set a clear objective such as:

42. Find best forecast for gas prices

43. Find the overall trend of gas prices from multiple forecast models

44. Find seasonal indices for gas prices

45. Find relationships (or lack of) between variables gas prices (dependent), and GDP(independent), interest rate(independent)…Copyright 2010 DeepThought, Inc. 9

47. Does it have a trend, seasonality, or cyclicality

48. Select the appropriate methods to use given the objective and data type

49. Use (economic, financial, est.) theory to back your model

50. Start with simple models

51. Build on good simple modelsCopyright 2010 DeepThought, Inc. 10

53. F-Test

54. F-Test P-Value

55. Rule of thumb: F-Test P-Value < 0.05

56. Accuracy (the lower the better except R2)

57. SSE: Sum of Squared Errors

58. RMSE: Root Mean Square Error

59. MAPE: Mean Average Percentage Error

60. R2/ Adjusted R2: % Error Captured by ModelCopyright 2010 DeepThought, Inc. 11

62. Forecasting

63. Understanding trend, seasonality, and cyclicality

64. Understanding relationships between different variablesCopyright 2010 DeepThought, Inc. 12