Forecasting: an introduction. There are a variety of ad hoc methods as well as a variety of statistically derived methods.

Similar documents
Chapter 5 Univariate time-series analysis. () Chapter 5 Univariate time-series analysis 1 / 29

This homework assignment uses the material on pages ( A moving average ).

Version A. Problem 1. Let X be the continuous random variable defined by the following pdf: 1 x/2 when 0 x 2, f(x) = 0 otherwise.

Chapter 5 Univariate time-series analysis. () Chapter 5 Univariate time-series analysis 1 / 59

Introduction Dickey-Fuller Test Option Pricing Bootstrapping. Simulation Methods. Chapter 13 of Chris Brook s Book.

Statistics for Business and Economics

MAFS Computational Methods for Pricing Structured Products

Chapter 5. Continuous Random Variables and Probability Distributions. 5.1 Continuous Random Variables

12. Conditional heteroscedastic models (ARCH) MA6622, Ernesto Mordecki, CityU, HK, 2006.

AP Statistics Chapter 6 - Random Variables

Week 7 Quantitative Analysis of Financial Markets Simulation Methods

Statistics and Finance

Probability Theory and Simulation Methods. April 9th, Lecture 20: Special distributions

1. You are given the following information about a stationary AR(2) model:

10/1/2012. PSY 511: Advanced Statistics for Psychological and Behavioral Research 1

Index Models and APT

Linear Regression with One Regressor

Chapter 5 Discrete Probability Distributions. Random Variables Discrete Probability Distributions Expected Value and Variance

Exam M Fall 2005 PRELIMINARY ANSWER KEY

BINOMIAL SERIES PART 2

Discrete Random Variables

LONG MEMORY IN VOLATILITY

Binomial Probabilities The actual probability that P ( X k ) the formula n P X k p p. = for any k in the range {0, 1, 2,, n} is given by. n n!

Statistics and Their Distributions

Discrete Probability Distribution

The University of Chicago, Booth School of Business Business 41202, Spring Quarter 2011, Mr. Ruey S. Tsay. Solutions to Final Exam.

Mathematical Annex 5 Models with Rational Expectations

Chapter 8: CAPM. 1. Single Index Model. 2. Adding a Riskless Asset. 3. The Capital Market Line 4. CAPM. 5. The One-Fund Theorem

Derivation Of The Capital Asset Pricing Model Part I - A Single Source Of Uncertainty

Hedging and Regression. Hedging and Regression

Econ 300: Quantitative Methods in Economics. 11th Class 10/19/09

1 The continuous time limit

The University of Chicago, Booth School of Business Business 41202, Spring Quarter 2009, Mr. Ruey S. Tsay. Solutions to Final Exam

Discrete probability distributions

Option Pricing. Chapter Discrete Time

2. The sum of all the probabilities in the sample space must add up to 1

Review for Final Exam Spring 2014 Jeremy Orloff and Jonathan Bloom

The Autocorrelation Function and AR(1), AR(2) Models

Time Observations Time Period, t

Lattice Model of System Evolution. Outline

Practice Exam 1. Loss Amount Number of Losses

Chapter 7. Confidence Intervals and Sample Size. Bluman, Chapter 7. Friday, January 25, 13

Booth School of Business, University of Chicago Business 41202, Spring Quarter 2016, Mr. Ruey S. Tsay. Solutions to Midterm

University of Phoenix Material

Modelling Returns: the CER and the CAPM

Monetary Economics Measuring Asset Returns. Gerald P. Dwyer Fall 2015

Section 5.5 Factoring Trinomials, a = 1

Interval estimation. September 29, Outline Basic ideas Sampling variation and CLT Interval estimation using X More general problems

درس هفتم یادگیري ماشین. (Machine Learning) دانشگاه فردوسی مشهد دانشکده مهندسی رضا منصفی

Chapter 5 Finite Difference Methods. Math6911 W07, HM Zhu

Statistics for Managers Using Microsoft Excel 7 th Edition

Relations between Prices, Dividends and Returns. Present Value Relations (Ch7inCampbell et al.) Thesimplereturn:

Institute of Actuaries of India Subject CT6 Statistical Methods

Forecasting Financial Markets. Time Series Analysis

Martingales, Part II, with Exercise Due 9/21

Financial Econometrics Lecture 5: Modelling Volatility and Correlation

Booth School of Business, University of Chicago Business 41202, Spring Quarter 2014, Mr. Ruey S. Tsay. Solutions to Midterm

Chapter 5. Sampling Distributions

Discrete Random Variables and Probability Distributions. Stat 4570/5570 Based on Devore s book (Ed 8)

CHAPTER 6 Random Variables

The University of Chicago, Booth School of Business Business 41202, Spring Quarter 2012, Mr. Ruey S. Tsay. Solutions to Final Exam

Quantitative Methods for Economics, Finance and Management (A86050 F86050)

Lecture 3: Return vs Risk: Mean-Variance Analysis

SYLLABUS AND SAMPLE QUESTIONS FOR MSQE (Program Code: MQEK and MQED) Syllabus for PEA (Mathematics), 2013

SOCIETY OF ACTUARIES Advanced Topics in General Insurance. Exam GIADV. Date: Thursday, May 1, 2014 Time: 2:00 p.m. 4:15 p.m.

CPSC 540: Machine Learning

Booth School of Business, University of Chicago Business 41202, Spring Quarter 2010, Mr. Ruey S. Tsay. Solutions to Midterm

CCAC ELEMENTARY ALGEBRA

Developmental Math An Open Program Unit 12 Factoring First Edition

Conditional Heteroscedasticity

The Normal Distribution

The rth moment of a real-valued random variable X with density f(x) is. x r f(x) dx

ARCH and GARCH models

Chapter 16. Random Variables. Copyright 2010 Pearson Education, Inc.

Asymmetric Information: Walrasian Equilibria, and Rational Expectations Equilibria

-5y 4 10y 3 7y 2 y 5: where y = -3-5(-3) 4 10(-3) 3 7(-3) 2 (-3) 5: Simplify -5(81) 10(-27) 7(9) (-3) 5: Evaluate = -200

Business Statistics 41000: Probability 3

Lecture 18 Section Mon, Feb 16, 2009

Math 140 Introductory Statistics. Next test on Oct 19th

Course information FN3142 Quantitative finance

Hints on Some of the Exercises

Inequalities - Solve and Graph Inequalities

Portfolio theory and risk management Homework set 2

Chapter 8 To Infinity and Beyond: LIMITS

Lecture 18 Section Mon, Sep 29, 2008

Estimating parameters 5.3 Confidence Intervals 5.4 Sample Variance

u (x) < 0. and if you believe in diminishing return of the wealth, then you would require

CPSC 540: Machine Learning

Shifting our focus. We were studying statistics (data, displays, sampling...) The next few lectures focus on probability (randomness) Why?

CHAPTER 3 MA-FILTER BASED HYBRID ARIMA-ANN MODEL

ECO 317 Economics of Uncertainty Fall Term 2009 Tuesday October 6 Portfolio Allocation Mean-Variance Approach

Homework Assignments for BusAdm 713: Business Forecasting Methods. Assignment 1: Introduction to forecasting, Review of regression

2 Control variates. λe λti λe e λt i where R(t) = t Y 1 Y N(t) is the time from the last event to t. L t = e λr(t) e e λt(t) Exercises

Chapter 3 - Lecture 3 Expected Values of Discrete Random Va

Sampling and sampling distribution

CS145: Probability & Computing

King s College London

Chapter 14 - Random Variables

ECE 295: Lecture 03 Estimation and Confidence Interval

Simulation Wrap-up, Statistics COS 323

Transcription:

Forecasting: an introduction Given data X 0,..., X T 1. Goal: guess, or forecast, X T or X T+r. There are a variety of ad hoc methods as well as a variety of statistically derived methods. Illustration of ad hoc methods: exponentially weighted moving average (EWMA): ˆX T = X T 1 + ax T 2 + a 2 X T 3 + + a T 1 X 0 c(a, T) where c(a, T) makes it a weighted average: c(a, T) = (1 a T )/(1 a). For a near 1 almost using sample mean. For a near 0 virtually using X T 1. Choose a to trade off desire to use lots of data against possibility that structure of series has changed over time. 210

Statistically based methods: use some measure of the size of X T ˆX T Mean Squared Prediction Error (MSPE): E([X T ˆX T ] 2 ) is the most common. In general ˆX T is some function f(x 0,..., X T 1 ). MSPE is minimized by ˆX T = E(X T X 0,..., X T 1 ) Hard to compute for most X distributions. For Gaussian processes the solution is the usual linear regression of X T on the data, namely ˆX T = µ T + a 1 (X T 1 µ T 1 ) + a T (X 0 µ 0 ) where the coefficient vector a is given by a = Cov(X T,(X T 1,..., X 0 ) T ) Var(X T 1,..., X 0 ) 1 For large T computation difficult but there are some shortcuts. 211

Forecasting AR(p) processes When the process is an AR the computation of the conditional expectation is easier: ˆX T = E(X T X 0,..., X T 1 ) = E(ǫ T + = p i=1 p i=1 a i X T i For r > 0 we have the recursion E(X T+r X 0,..., X T 1 ) =E(ǫ T+r + = p i=1 p i=1 a i ˆX T+r i a i X T i X 0,..., X T 1 ) a i X T+r i X 0,..., X T 1 ) Note forecast into future uses current values where these are available and forecasts already calculated for other X s. 212

Forecasting ARMA(p, q) processes An ARMA(p, q) can be inverted to be an infinite order AR process. Then use method just given for AR. But: now formula mentions values of X t for t < 0. In practice: truncate series, and ignore missing terms in forecast, assuming that the coefficients of these omitted terms are very small. Remember each term is built up out of a geometric series for (I αb) 1 with α < 1. More direct method: ˆX T+r = E(ǫ T+r X) + + q i=1 p i=1 b i E(ǫ T+r i X) a i ˆX T+r i where conditioning X means given data observed. 213

For T + r i T conditional expectation is 0. For T +r i < T need to guess value of ǫ T+r i. The same recursion can be re-arranged to help compute E(ǫ t X) for 0 t T 1, at least approximately: E(ǫ t X) = X t a i X t i + b i E(ǫ t i X) Recursion works backward; generally start recursion by putting ˆǫ t = 0 for negative t and then using the recursion. Coefficients b are such that the effect of getting these values of ǫ wrong is damped out at a geometric rate as we increase t. So: if we have enough data and the smallest root of the characteristic polynomial for the MA part is not too close to 1 then we will have accurate values for ˆǫ t for t near T. 214

Computed estimates of the epsilons can be improved by backcasting the values of ǫ t for negative t and then forecasting and backcasting, etc. Forecasting ARIMA(p, d, q) series Suppose Z = (I B) d X for X ARIMA(p, d, q). Compute Z, forecast Z and reconstruct X by undoing the differencing. For d = 1 for example we just have ˆX t = Ẑ t + ˆX t 1. 215

Forecast standard errors Note: computations of conditional expectations used fact that a s and b s are constants the true parameter values. In practice: replace parameter values with estimates. Quality of forecasts summarized by forecast standard error: E[(X t ˆX t ) 2 ]. We will compute this ignoring the estimation of the parameters and then discuss how much that might have cost us. If ˆX t = E(X t X) then E( ˆX t ) + E(X t ) so that our forecast standard error is just the variance of X t ˆX t. 216

First one step ahead forecasting for AR(1): X T ˆX T = ǫ T. The variance of this forecast is σ 2 ǫ so that the forecast standard error is just σ ǫ. For forecasts further ahead in time we have and ˆX T+r = a ˆX T+r 1 X T+r = ax T+r 1 + ǫ T+r Subtracting we see that Var(X T+r ˆX T+r ) = σ 2 ǫ + a 2 Var(X T+r 1 ˆX T+r 1 ) so may calculate forecast standard errors recursively. As r forecast variance converges to σ 2 ǫ /(1 a 2 ) which is simply the variance of individual Xs. When forecasting a stationary series far into future, forecast standard error is just standard deviation of series. 217

General ARMA(p, q). Rewrite process as infinite order AR X t = c s X t s + ǫ t s>0 Ignore truncation of infinite sum in forecast: X T ˆX T = ǫ T so one step ahead forecast standard error is σ ǫ. Parallel to the AR(1) argument: X T+r ˆX T+r = r 1 j=0 c r j (X T+j ˆX T+j )+ǫ T+r. Errors on right hand side not independent of one another. So: computation of variance requires either computation of covariances or recognition of fact that right hand side is a linear combination of ǫ T,..., ǫ T+r. 218

Simpler approach: write process as infinite order MA: X t = ǫ t + s>0 d s ǫ t s for suitable coefficients d s. Treat conditioning on data as being effectively equivalent to conditioning on all X t for t < T. Effectively conditioning on ǫ t for all t < T. This means that E(X T+r X T 1, X T 2,...) = E(X T+r ǫ T 1, ǫ T 2,...) = s>r d s ǫ T+r s and the forecast error is just X T+r ˆX T+r = ǫ T+r + r s=1 d s ǫ T+r s so that the forecast standard error is σ ǫ 1 + r s=1 d 2 s. Again as r this converges to σ X. 219

ARIMA(p, d, q) process: (I B) d X = W where W is ARMA(p, q). Forecast errors in X can be written as a linear combination of forecast errors for W. So forecast error in X can be written as a linear combination of underlying errors ǫ t. Example: ARIMA(0,1,0): X t = ǫ t + X t 1. The forecast of ǫ T+r is 0. So forecast of X T+r is ˆX T+r = ˆX T+r 1 = = X T 1. The forecast error is ǫ T+r + + ǫ T whose standard deviation is σ r + 1. Notice that the forecast standard error grows to infinity as r. 220

For a general ARIMA(p,1, q) we have and ˆX T+r = ˆX T+r 1 + Ŵ T+r X T+r ˆX T+r = (W T+r Ŵ T+r ) + + (W T Ŵ T ) which can be combined with the expression above for the forecast error for an ARMA(p, q) to compute standard errors. Software S-Plus function arima.forecast can do forecasting. Use predict.arima in R. Comments Effects of parameter estimation ignored. 221

In ordinary least squares when we predict the Y corresponding to a new x we get a forecast standard error of V ar(y xˆβ) = V ar(ǫ + x(β ˆβ)) which is σ 1 + x(x T X) 1 x T. The procedure used here corresponds to ignoring the term x(x T X) 1 x T which is the variance of the fitted value. Typically this value is rather smaller than the 1 to which it is added. In a 1 sample problem for instance it is simply 1/n. Generally the major component of forecast error is the standard error of the noise and the effect of parameter estimation is unimportant. 222

Prediction Intervals In regression sometimes compute prediction intervals Ŷ ± cˆσŷ Multiplier c adjusted to make coverage probability P( Y Ŷ cˆσ 1) close to desired coverage probability such as 0.95. If the errors are normal then we can get c by taking t 0.025,n p 1 + x(x T X) 1 x T. When the errors are not normal, however, the error in Y Ŷ is dominated by ǫ which is not normal so that the coverage probability can be radically different from the nominal. Moreover, there is no particular theoretical justification for the use of t critical points. However, even for non-normal errors the prediction standard error is a useful summary of the accuracy of a prediction. 223