Module - 5 Time Series

Contents: 5.1 Introduction

5.1.1. Role of time Series

5.2. Components of a time series

5.2.1 5.2.2 5.2.3 5.2.4 Secular Trend Seasonal variation Cyclical variation Irregular variation

5.3 Measurement of Trends

5.3.1 5.3.2 5.3.3 5.3.4 Freehand method The method of semi-averages The method of moving averages The method of curve fitting by the Principle of Least Squares

5.4 Mathematical Models

5.4.1 5.4.2 5.4.3 Additive model Multiplicative model Mixed models

Module - 5 Time Series 5.1 Introduction

Realization of the fact that "Time is Money" in business activities, the dynamic decision technologies presented here, have been a necessary tool for applying to a wide range of managerial decisions successfully where time and money are directly related. In making strategic decisions under uncertainty, we all make forecasts. We may not think that we are forecasting, but our choices will be directed by our anticipation of results of our actions or inactions. Indecision and delays are the parents of failure. This site is intended to help managers and administrators do a better job of anticipating, and hence a better job of managing uncertainty, by using effective forecasting and other predictive techniques. A time series is a chronological sequence of observations on a particular variable. Usually the observations are taken at regular intervals (days, months, years), but the sampling could be irregular. A time series analysis consists of two steps: (1) building a model that represents a time series, (2) using the model to predict (forecast) future values. The time-series can be represented as a curve that evolves over time. Forecasting the timeseries mean that we extend the historical values into the future where the measurements are not available yet.

There are some subtleties in the definition a time-series forecast. For example, the historical data might be daily sales and but you need monthly forecasts. Grouping the values according to a certain period (ex: month) is called time-series The following are few examples of time series data: 1. Profits earned by a company for each of the past five years. 2. Workers employed by a company for each of the past 15 years. 3. Number of students registered for the MBA programme of an institute for each of the past five years. 4. The weekly wholesale price index for each of the past 30 weeks. 5. Number of fatal road accidents in Delhi for each day for the past two months.

5.1.1. Role of time Series

1. A time series analysis enables one to study such movements as cycles that fluctuate around the trend. Knowledge of cyclical pattern in certain series of data will be helpful in making generalisations in the concerned business or industry. 2. The analysis of a time series enables us to understand the past behavior or performance. We can know how the data have changed over time and find out the probable reasons responsible for such changes. If the past performance, say, of a company, has been poor, it can take corrective measures to arrest the poor performance. 3. A time series analysis helps directly in business planning. A firm can know the long-term trend in the sale of its products. It can find out at what rate sales have been increasing over the years. This may help it in making projections of its sales for the next few years and plan the procurement of raw material, equipment and manpower accordingly. 4. A time series analysis enables one to make meaningful comparisons in two or more series regarding the rate or type of growth. For example, growth in consumption at the national level can be compared with that in the national income over specified period. Such comparisons are of considerable importance to business and industry. 5. A time series analysis helps in evaluating current accomplishments. The actual performance can be compared with the expected performance and the cause of variation analysed e.g. if we know how much is the effect of seasonality on business we may device ways and means of ironing out the seasonal influence or decreasing it by producing commodities with complementary seasons.

5.2. Components of a time series

1 2 3 4 Secular Trend - the smooth long term direction of a time series Seasonal Variation - Patterns of change in a time series within a year which tends to repeat each year Cyclical Variation - the rise and fall of a time series over periods longer than one year Irregular Variation - classified into: Episodic - unpredictable but identifiable Residual - also called chance fluctuation and unidentifiable

5.2.1

Secular Trend

With the first type of change, secular trend, the value of the variable tends to increase or decrease over a long period of time. The steady increase in the cost of living recorded by the Consumer Price Index is an example of secular trend. From year to individual year, the cost of living varies a great deal, but if we examine a long- term period, we see that the trend is toward a steady increase. Figure shows a secular trend in an increasing but fluctuating time series.

5.2.2

Seasonal variation
The third kind of change in time-series data is seasonal variation. As we might expect from the name, seasonal variation involves patterns of change within a year that tend to be repeated from year to year. For example, a physician can expect a substantial increase in the number of flu cases every winter and of poison in every summer. Since these are regular patterns, they are useful in forecasting the future. In figure 1(c), we see a seasonal variation. Notice how it peaks in the fourth quarter of each year. 1 2 3 4 Sales of ice cream will be higher in summer than in winter, and sales of overcoats will be higher in autumn than in spring. Shops might expect higher sales shortly before Christmas or in their winter and summer sales. Sales might be higher on Friday and Saturday than on Monday. The telephone network may be heavily used at a certain times of the day (such as midmorning and mid-afternoon) and much less used at other times (such as in the middle of the night)

S asonal Va tion ea sona Varia l ria

4
S ales of Wi ldcat sai lb oats Sales of Wi ld cat sailb oats (miill io ns of dol lars) (m ll ions of d oll ars)

3
L inear trend Lin ear tren d

2 1
| Jully Ju y 2001 | Jul y 2002 2002 | Jul y Ju ly 2003 | Jul y 2004 2004

5.2.3

Cyclical variation
The second type of variation seen in a time series in cyclical fluctuation. The most common example of cyclical fluctuation is the business cycle. Over time, there are years when the business cycle hits a peak above the trend line. At other times, business activity is likely to slump, hitting a low point below the trend line. The time between bitting peaks or falling to low points is a least 1 year, and it can be as many as 15 or 20 years. Figure 1(b) illustrates a typical pattern of cyclical fluctuation above and below a secular trend line. Note that the cyclical movements do not follow any regular pattern but move in a somewhat unpredictable manner.

C cl a V r t n y lic l aiaio ic
Cyclical act ivity activit y Z1 P1 Z2 P2 P

V1

V2 t

Z1- De lin Z - Dc e 1 e lin P1- P s e y P1- Pro p rit ros rity V1- De re s n V - D pre ion 1 e s io s p v et ro e Z - Im rov mn 2

B s esC c uin s y le
Imro e e t p v mn P o p rit r se y

D pes n e r sio

Dc e elin

Cyclica Compon nts l pone ts Cyclical en

Ct 1.15 1.15 1.10 1.10 1.05 1.05 1.00 1.00 .95 .90 | | | | | | | | 1 2 3 4 5 6 7 8 1 4 8 1997 2001 1997 1999 2001 2003 t

Start

End

These are medium-term changes in results caused by circumstances which repeat in cycles. In business, cyclical variations are commonly associated with economic cycles, successful booms and slumps in the economy. Economic cycles may last a few years. Cyclical Variations are longer term than seasonal variations.

5.2.4

Irregular variation

Irregular variation is the fourth type of change in time-series analysis. In many situations, the value of a variations describe such movements. The effects of the Middle East conflict in 1973, the Iraqi situation in 1990 on gasoline prices in the United States are examples of irregular variation. Figure 1 (d) illustrates irregular variation.

Thus far, we have referred to a time series as exhibiting one or another of these four types of variation. In most instances, however, a time series will contain several of these components. Thus, we can describe the overall variation in a single time series in terms of these four different kinds of variation. In the following sections, we will examine the four components and the ways in which we measure each. Careful analysis of time-series data helps managers analyze past trends and plan for future customer demand. Knowing about the three analyzable components, the secular trend, cyclical fluctuation. and seasonable variation enables managers to have enough resources-such as staff and inventory-to meet customers' needs. Once these three components are well understood, it's much easier to interpret a seemingly erratic pattern of sales. Then the fourth component, irregular variation, can possible be linked with an identifiable cause. You can see that the link between measured performance and causes fits well with a Total quality Management approach to business. The trend is the long-term movement of a time series. In other words, an increase or decrease in the values of a variable occurring over a period of several years gives a trend. If the values of a variable remain stationery over several years, then we can say that there is no trend in that time series. When we study the growth in industrial production from 1990 to 2000, we are trying to find the trend in industrial production for this time period. The trend may be increasing or decreasing.

5.3 Measurement of Trends

There are various methods for measuring trends: 1. Freehand method. 2. The method of semi-averages 3. The method of moving averages 4. The method of curve fitting by the Principle of Least Squares.

5.3.1 Freehand method

This is the simplest method of finding a trend line. The procedure involves first the plotting of the time series on a graph and then fitting a straight line through the plotted points in such a way that the straight line shows the trend of the time series. This is illustrated with the hypothetical data in Table given below: Table Sale of Product Y, 1995-2001 Year (X) 1995 1996 1997 1998 1999 2000 2001 Sale (Y) Million Rs 10 20 15 25 37 35 40

Advantages
1. The Freehand method is a very simple method of estimating trend. 2. There is flexibility in this method as it can be used regardless whether the trend is a straight line or non-linear. 3. If the statistician is well-conversant with the movement of the particular variable involved in the time series, the use of this method may even give a better expression to the long-term movement than the trend fitted by a rigid mathematical formula.

Limitations
This is a highly subjective method as the trend line fitted to the same set of data by this method will vary from one person to another. 2. In view of the trend line being highly subjective, it is not an appropriate method for making predictions. 3. It means very long experience on the part of the statistician to use this method, otherwise, the trend fitted would not be of much use.

5.3.2 The method of semi-averages

When the method of semi-averages is used, the given time series is divided into two parts preferably with the same number of years. The average of each part is calculated and then a trend line through these averages is fitted. This is illustrated with the data given in Table. 1 Year 1994 1995 1996 1997 1998 1999 2000 2001 Table Production from 1994-2001 X 0 1 2 3 4 5 6 7 Y 10 12 18 20 20 25 23 32 100/4=25 Average

60/4=15

The average of first part of the data is 15 and that of the second part is 25. Since 15 is the average of 1994, 1995, 1996 and 1997, 15 is plotted in between 1995 and 1996, which is the middle of the 4-year period. Likewise, 25 is plotted in between

1999 and 2000. Then these points are joined by a straight line, which is a semi-average trend line. This is shown in figure

Advantages
1. The method of semi-averages is simple to use as anyone can use it conveniently. 2. This is an objective method as anyone applying it to the given set of data would get the same trend line.

Limitations
1. This method will always give a straight line trend regardless of the nature of the given set of

data. Thus, it assumes a straight line relationship, which may not be true. 2. This method may give wrong trend-line on account of the limitations of arithmetic average. In case there is an extreme value in either half or both halves of the time series, then the trend line will not give a realistic growth of the phenomenon being measured. In order to overcome this problem, it is necessary to ensure that the data do not have extreme values.

5.3.3 The method of moving averages

The method of moving averages is used not only to fit trend lines but also to seasonal and cyclical variations. The following example illustrates how the method is used. For Example 1 Suppose we are given a time series data for 12 years-1989 to 2000 relating to sales of a certain business firm and we have to find out the three-year moving averages, starting from 1989. Year 1989 1990 1991 1992 1993 1994 Sales (Million Rs.) 10 15 20 25 15 12 Year 1995 1996 1997 1998 1999 2000 Sales Rs.) 15 24 15 21 15 24 (Million

Advantages
The method of moving averages is simpler method than the method of least squares. 2. The general movement of the data is reflected in the moving averages. As such, the trend line

is based on the data rather than on the statisticians choice of a mathematical function. 3. In case the period of moving averages coincides with that of cyclical fluctuations in the data, this method automatically removes such fluctuations.

Limitations
1. The method does not cover all the years so far as trend values are concerned. 2. It needs to be exercised very carefully as there are no definite rules regarding the period of moving averages. 3. This method cannot be used for forecasting as it is not represented by a mathematical function. 4. If the trend is non-linear, the moving averages may considerably deviate from it.

5.3.4 The method of curve fitting by the Principle of Least Squares

Among the methods of fitting a straight line to a series of data, this is the most frequently used method. As we have seen earlier that the equation of a straight line is Y = a + bX, where Y is the time period, say, year X is the value of the item measured against time, a is the Y-intercept and b is the coefficient of X that shows the slope of the straight line. In order to find out the values of a and b, the following two equations are solved: Y = Na + b X XY =a X +b X2

5.4 Mathematical Models Used for the Decomposition of Time Series of Data
1.

Additive model

2. Multiplicative model 3. Mixed models 5.4.1 Additive model

Here we assume that the relationship amongst these components is additive, that is, 1 Y=T+S+C+I where Y is the result of the four components, T = trend, S =seasonal variation, C = cyclical variation and I = irregular variation The additive model assumes that all the four components operate independently. S =0, for any year C =0, for any cycle I =0, in the long-term period

5.4.2 Multiplicative model

Here we assume that there is a multiplicative relationship amongst these four components. In symbols this can be written as Y=TXSXCXI This model assumes that the four components are due to different causes but they are not necessarily independent and they can affect each other.

5.4.3 Mixed models

The components in a time series may be combined in large number of other ways. The different models, defined under different assumption, will yield different results. Y = TSC + I Y = TC + SI Y = T+SCI Y = T + S + CI