Lecture-6

(Chapter-3)
FORECASTING - IV

ASSOCIATIVE MODELS
Linear Regression
Statistically Develop an Equation to
Summarize Affect of Predictor
Variables That Help Predict Values of
Predicted Variable or Variable of
Interest
Regression by Least Squares Method
Linear Relationship Between Two
Variables

ASSOCIATIVE MODELS
Linear Regression
= a + b x
Where

= Predicted (Dependent) Variable

x = Predictor (Independent) Variable
a = Value of y When x = 0
b = Slope of the Regression Line

ASSOCIATIVE MODELS
Linear Regression
= a + b x
b = [n (x y) x y ] / [n x2 ( x)2]
a = [ y b x] / n]
n = Number of Data Points

TIME-SERIES MODELS
Linear Regression
MICROSOFT EXCEL
Files -> Options -> Add-Ins -> Excel Add-Ins
Clock Go to Open Add-Ins Window
Check Analysis Toolpack & Click OK
Data Analysis Option Will Appear Under
Data Tab
For Graph, Use Scatter Plot & Trend Line

ASSOCIATIVE MODELS
Linear Regression Coefficient of Correlation
Strength of Relationship Between Two Variables
How Much Variation in y Explained by x
Does Not Indicate Causality!
Ranges From 1.00 to +1.00

r = [n (x y) x y ]
Divided By

[n x2 ( x)2]

[n y2 ( y)2]

r2 Ranges From 0 to 1.00

Indicates Whether Independent Variable Good Predictor of

Dependent Variable or Not

ASSOCIATIVE MODELS
Linear Regression Significance F-

Value
Sig F < 0.05 is Good Otherwise Change

Independent Variable

Linear Regression P-Values

P-Values < 0.05 is Good Otherwise
Change Independent Variable Where PValue > 0.05

ASSOCIATIVE MODELS
Linear Regression Coefficients
Regression Line:
Monthly Income = 451.11 +
50.179*Height
Use for Forecasting at Other Height

Values

ASSOCIATIVE MODELS
Linear Regression Residuals
Difference Between Observed Value of
Dependent Variable (y) & Predicted
Value () is theResidual(e)
= a + b x + e e = y
Each Data Point has OneResidual
Both Sum & Mean of ResidualsEqual
Zero

ASSOCIATIVE MODELS
Linear Regression Properties
Variation of Data Points Random
Deviations Normally Distributed
Data May be Time-Dependent
Multiple Regression With Time as
One of the Independent Variables
Small Correlation Coefficient Other
Variables May be More Important

ASSOCIATIVE MODELS
Linear Regression Weaknesses
Limited to Linear Relationship
Limited to Single Independent Variable
Minimum 20 Data Points
All Observations Weighed Equally
Need to Forecast Independent Variable
Before Predicting Dependent Variable

ASSOCIATIVE MODELS
Linear Regression Indicators
Uncontrollable Variables That Lead to
Change in Predicted Variable or Variable
of Interest e.g. CPI, Discount Rates, Stock
Market Index, GDP, Population, Climate etc.
Logical Relationship Should Exist
Indicator Movement Precedes Change in
Predicted Variable
High Correlation Should Exist

ACCURACY OF
FORECASTS
Minimize Forecast Errors
Error = Actual Forecast
Measures of Errors:
Mean Absolute Deviation (MAD)
Mean Squared Error (MSE)
Mean Absolute Percent Error (MAPE)

ACCURACY OF
FORECASTS
MAD = [ (Actualt Forecastt)] / n
MSE = [ (Actualt Forecastt)2] / (n 1)
MAPE =

[ (Actualt Forecastt) / Actualt] *100 /

n

ACCURACY OF
FORECASTS
MAD = Easy But Weights Errors

Equally
MSE = Gives More Weight to Larger

Errors
MAPE = Clarifies Perspective

CONTROLLING
FORECASTS
Control Chart
Visually Monitor Forecast Errors e.g.
Inadequate Model (Missing or New
Variables), Irregular Variations
(Weather, Natural Calamity), Incorrect
Application of Forecasting Technique or
Random Variations
Errors Should Vary Randomly

CONTROLLING
FORECASTS
Control Chart
Set a Range of Acceptable Variations
Center Line Zero Error
UCL Upper Control Limit
LCL Lower Control Limit