Time Series Analysis and Forecasting I

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Time Series Analysis and Forecasting I
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Introduction

• A time series is a set of observations generated
  sequentially in time
• Continuous vs. discrete time series
• The observations from a discrete time series,
  made at some fixed interval h, at times ?1, ?2,,
  ?N may be denoted by z(?1), z(?2),, z(?N)

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Introduction (cont.)

• Discrete time series may arise in two ways
• 1- By sampling a continuous time series
• 2- By accumulating a variable over a period of
  time
• Characteristics of time series
• Time periods are of equal length
• No missing values

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Components of a time series
Zt Ft at
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Areas of application

• Forecasting
• Determination of a transfer function of a system
• Design of simple feed-forward and feedback
  control schemes

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Forecasting

• Applications
• Economic and business planning
• Inventory and production control
• Control and optimization of industrial processes
• Lead time of the forecasts
• is the period over which forecasts are needed
• Degree of sophistication
• Simple ideas
• Moving averages
• Simple regression techniques
• Complex statistical concepts
• Box-Jenkins methodology

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Approaches to forecasting

• Self-projecting approach

• Cause-and-effect approach

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Approaches to forecasting (cont.)

• Self-projecting approach
• Advantages
• Quickly and easily applied
• A minimum of data is required
• Reasonably short-to medium-term forecasts
• They provide a basis by which forecasts developed
  through other models can be measured against
• Disadvantages
• Not useful for forecasting into the far future
• Do not take into account external factors

• Cause-and-effect approach
• Advantages
• Bring more information
• More accurate medium-to long-term forecasts
• Disadvantages
• Forecasts of the explanatory time series are
  required

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Some traditional self-projecting models

• Overall trend models
• The trend could be linear, exponential,
  parabolic, etc.
• A linear Trend has the form
• Trendt A Bt
• Short-term changes are difficult to track
• Smoothing models
• Respond to the most recent behavior of the series
• Employ the idea of weighted averages
• They range in the degree of sophistication
• The simple exponential smoothing method

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Some traditional self-projecting models (cont.)

• Seasonal models
• Very common
• Most seasonal time series also contain long- and
  short-term trend patterns
• Decomposition models
• The series is decomposed into its separate
  patterns
• Each pattern is modeled separately

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Drawbacks of the use of traditional models

• There is no systematic approach for the
  identification and selection of an appropriate
  model, and therefore, the identification process
  is mainly trial-and-error
• There is difficulty in verifying the validity of
  the model
• Most traditional methods were developed from
  intuitive and practical considerations rather
  than from a statistical foundation
• Too narrow to deal efficiently with all time
  series

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ARIMA models

• Autoregressive Integrated Moving-average
• Can represent a wide range of time series
• A stochastic modeling approach that can be used
  to calculate the probability of a future value
  lying between two specified limits

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ARIMA models (Cont.)

• In the 1960s Box and Jenkins recognized the
  importance of these models in the area of
  economic forecasting
• Time series analysis - forecasting and control
• George E. P. Box Gwilym M. Jenkins
• 1st edition was in 1976
• Often called The Box-Jenkins approach

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Transfer function modeling

• Yt ?(B)Xt where
• ?(B) ?0 ?1B ?2B2 ..
• B is the backshift operator
• BmXt Xt - m

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Transfer function modeling (cont.)

• The study of process dynamics can achieve
• Better control
• Improved design
• Methods for estimating transfer function models
• Classical methods
• Based on deterministic perturbations
• Uncontrollable disturbances (noise) are not
  accounted for, and hence, these methods have not
  always been successful
• Statistical methods
• Make allowance for noise
• The Box-Jenkins methodology

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Process control

• Feed-forward control

• Feedback control

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Process control (cont.)
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Process control (cont.)

• The Box-Jenkins approach to control is to typify
  the disturbance by a suitable time series or
  stochastic model and the inertial characteristics
  of the system by a suitable transfer function
  model
• The Control equation, allows the action which
  should be taken at any given time to be
  calculated given the present and previous states
  of the system
• Various ways corresponding to various levels of
  technological sophistication can be used to
  execute a control action called for by the
  control equation

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The Box-Jenkins model building process
Model identification
Model estimation
Is model adequate ?
No
Modify model
Yes
Forecasts
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The Box-Jenkins model building process (cont.)

• Model identification
• Autocorrelations
• Partial-autocorrelations
• Model estimation
• The objective is to minimize the sum of squares
  of errors
• Model validation
• Certain diagnostics are used to check the
  validity of the model
• Model forecasting
• The estimated model is used to generate forecasts
  and confidence limits of the forecasts

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Important Fundamentals

• A Normal process
• Stationarity
• Regular differencing
• Autocorrelations (ACs)
• The white noise process
• The linear filter model
• Invertibility

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A Normal process (A Gaussian process)

• The Box-Jenkins methodology analyze a time series
  as a realization of a stochastic process.
• The observation zt at a given time t can be
  regarded as a realization of a random variable zt
  with probability density function p(zt)
• The observations at any two times t1 and t2 may
  be regarded as realizations of two random
  variables zt1, zt2 and with joint probability
  density function p(zt1, zt2)
• If the probability distribution associated with
  any set of times is multivariate Normal
  distribution, the process is called a normal or
  Gaussian process

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Stationary stochastic processes

• In order to model a time series with the
  Box-Jenkins approach, the series has to be
  stationary
• In practical terms, the series is stationary if
  tends to wonder more or less uniformly about some
  fixed level
• In statistical terms, a stationary process is
  assumed to be in a particular state of
  statistical equilibrium, i.e., p(zt) is the same
  for all t

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Stationary stochastic processes (cont.)

• the process is called strictly stationary
• if the joint probability distribution of any m
  observations made at times t1, t2, , tm is the
  same as that associated with m observations made
  at times t1 k, t2 k, , tm k
• When m 1, the stationarity assumption implies
  that the probability distribution p(zt) is the
  same for all times t

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Stationary stochastic processes (cont.)

• In particular, if zt is a stationary process,
  then the first difference ?zt zt - zt-1and
  higher differences ?dzt are stationary
• Most time series are nonstationary

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Achieving stationarity

• Regular differencing (RD)
• (1st order) ?zt (1 B)zt zt zt-1
• (2nd order) ?2zt (1 B)2zt zt 2zt-1 zt-2
• B is the backward shift operator
• It is unlikely that more than two regular
  differencing would ever be needed
• Sometimes regular differencing by itself is not
  sufficient and prior transformation is also needed

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Some nonstationary series
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Some nonstationary series (cont.)
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Some nonstationary series (cont.)
How can we determine the number of regular
differencing ?
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Autocorrelations (ACs)

• Autocorrelations are statistical measures that
  indicate how a time series is related to itself
  over time
• The autocorrelation at lag 1 is the correlation
  between the original series zt and the same
  series moved forward one period (represented as
  zt-1)

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Autocorrelations (cont.)

• The theoretical autocorrelation function

• The sample autocorrelation

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Autocorrelations (cont.)

• A graph of the correlation values is called a
  correlogram
• In practice, to obtain a useful estimate of the
  autocorrelation function, at least 50
  observations are needed
• The estimated autocorrelations rk would be
  calculated up to lag no larger than N/4

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A correlogram of a nonstationary time seies
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After one RD
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After two RD
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The white noise process

• The Box-Jenkins models are based on the idea that
  a time series can be usefully regarded as
  generated from (driven by) a series of
  uncorrelated independent shocks at

• Such a sequence at, at-1, at-2, is called a
  white noise process

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The linear filter model

• A linear filter is a model that transform the
  white noise process at to the process that
  generated the time series zt

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The linear filter model (cont.)

• ?(B) is the transfer function of the filter

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The linear filter model (cont.)

• The linear filter can be put in another form

• This form can be written

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Stationarity and invertibility conditions for a
linear filter

• For a linear process to be stationary,

• If the current observation zt depends on past
  observations with weights which decrease as we go
  back in time, the series is called invertible
• For a linear process to be invertible,

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Model building blocks

• Autoregressive (AR) models
• Moving-average (MA) models
• Mixed ARMA models
• Non stationary models (ARIMA models)
• The mean parameter
• The trend parameter

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Autoregressive (AR) models

• An autoregressive model of order p

• The autoregressive process can be thought of as
  the output from a linear filter with a transfer
  function ?-1(B), when the input is white noise at
• The equation ?(B) 0 is called the
  characteristic equation

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Moving-average (MA) models

• A moving-average model of order q

• The moving-average process can be thought of as
  the output from a linear filter with a transfer
  function ?(B), when the input is white noise at
• The equation ?(B) 0 is called the
  characteristic equation

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Mixed AR and MA (ARMA) models

• A moving-average process of 1st order can be
  written as

• Hence, if the process were really MA(1), we would
  obtain a non parsimonious representation in terms
  of an autoregressive model

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Mixed AR and MA (ARMA) models (cont.)

• In order to obtain a parsimonious model,
  sometimes it will be necessary to include both AR
  and MA terms in the model
• An ARMA(p, q) model

• The ARMA process can be thought of as the output
  from a linear filter with a transfer function
  ?(B)/?(B), when the input is white noise at

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The Box-Jenkins model building process

• Model identification
• Autocorrelations
• Partial-autocorrelations
• Model estimation
• Model validation
• Certain diagnostics are used to check the
  validity of the model
• Model forecasting

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Partial-autocorrelations (PACs)

• Partial-autocorrelations are another set of
  statistical measures are used to identify time
  series models
• PAC is Similar to AC, except that when
  calculating it, the ACs with all the elements
  within the lag are partialled out (Box Jenkins,
  1976)

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Partial-autocorrelations (cont.)

• PACs can be calculated from the values of the ACs
  where each PAC is obtained from a different set
  of linear equations that describe a pure
  autoregressive model of an order that is equal to
  the value of the lag of the partial-autocorrelatio
  n computed
• PAC at lag k is denoted by ?kk
• The double notation kk is to emphasize that ?kk
  is the autoregressive parameter ?k of the
  autoregressive model of order k

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Model identification

• The sample ACs and PACs are computed for the
  series and compared to theoretical
  autocorrelation and partial-autocorrelation
  functions for candidate models investigated

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Stationarity and invertibility conditions

• For a linear process to be stationary,

• For a linear process to be invertible,

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Stationarity requirements for AR(1) model

• For an AR(1) to be stationary
• -1 lt ?1 lt 1
• i.e., the roots of the characteristic equation 1
  - ?1B 0 lie outside the unit circle
• For an AR(1) it can be shown that
• ?k ?1 ?k 1 which with ?0 1 has the solution
• ?k ?1k k gt 0
• i.e., for a stationary AR(1) model, the
  theoretical autocorrelation function decays
  exponentially to zero, however, the theoretical
  partial-autocorrelation function has a cut off
  after the 1st lag

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Invertibility requirements for a MA(1) model

• For a MA(1) to be invertible
• -1 lt ?1 lt 1
• i.e., the roots of the characteristic equation 1
  - ? 1B 0 lie outside the unit circle
• For a MA(1) it can be shown that

• i.e., for an invertible MA(1) model, the
  theoretical autocorrelation function has a cut
  off after the 1st lag, however, the theoretical
  partial-autocorrelation function decays
  exponentially to zero

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Higher order models

• For an AR model of order p gt 1
• The autocorrelation function consists of a
  mixture of damped exponentials and damped sine
  waves
• The partial-autocorrelation function has a cut
  off after the p lag
• For a MA models of order q gt 1
• The autocorrelation function has a cut off after
  the q lag
• The partial-autocorrelation function consists of
  a mixture of damped exponentials and damped sine
  waves

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Permissible regions for the AR and MA parameters
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Theoretical ACs and PACs (cont.)
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Theoretical ACs and PACs (cont.)
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Model identification
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Model estimation
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Model verification