Business Forecasting

Chapter 10
The BoxJenkins Method of
Forecasting

Chapter Topics

The BoxJenkins Models

Forecasting with Autoregressive Models (AR)

Forecasting with Moving Average Models

(MA)

Autoregressive Integrated Moving Average

(ARIMA) models

Trends and Seasonality in Time Series

Trends

Seasonal Data

Chapter Summary

Univariate Data

Stationary
Trend
Seasonality
Cyclical

A majority of the real-world data show

certain combinations of the above
patterns.

BoxJenkins Method
Besides the smoothing techniques,
what other methods can we use to
forecast univariate data?
Using BoxJenkins Methods
Capture the past pattern

Forecast the future

Why Use The BoxJenkins

Method?
When facing very complicated data
patterns such as a combination of a trend,
seasonal, cyclical, and random
fluctuations:
e.g. Earning data of a corporation
e.g. Forecasting stock price
e.g. Sales forecasting
e.g. Energy forecasting (electricity,
gas)

Why Use the BoxJenkins

Method?
When forecasting is the sole purpose
of the model.
Very reliable especially in short term
(06 months) prediction; reliable in
short-to-mid (6 months1.5years)
-term prediction.
Confidence intervals for the estimates
are easily constructed.

Pattern I: Stationary
Pattern 1: No TrendStationary
demand seems to cluster around a specific level.

Pattern II: Trend

Demand
consistent
ly
increases
or
decreases
over time.

Tim
e

Tim
e

Time

Time

2 0 0 2 /Q 4

2 0 0 2 /Q 2

2 0 0 1 /Q 4

2 0 0 1 /Q 2

2 0 0 0 /Q 4

2 0 0 0 /Q 2

1 9 9 9 /Q 4

1 9 9 9 /Q 2

1 9 9 8 /Q 4

1 9 9 8 /Q 2

1 9 9 7 /Q 4

1 9 9 7 /Q 2

1 9 9 6 /Q 4

1 9 9 6 /Q 2

1 9 9 5 /Q 4

1 9 9 5 /Q 2

1 9 9 4 /Q 4

1 9 9 4 /Q 2

1 9 9 3 /Q 4

1 9 9 3 /Q 2

1 9 9 2 /Q 4

1 9 9 2 /Q 2

1 9 9 1 /Q 4

1 9 9 1 /Q 2

1 9 9 0 /Q 4

1 9 9 0 /Q 2

10,000,000

B illio n K W H

Pattern III: Seasonality

U.S. Electricity Consumption

12,000,000

(Source: Historical Electricity Data, Energy Information

Association, http://www.eia.doe/gov)

8,000,000

6,000,000

Residential Consumption

4,000,000

Industrial Consumption

2,000,000

Commercial Consumption

2 0 0 2/5

2 0 0 0 /9

1 9 9 9 /1

1 9 9 7/5

1 9 9 5 /9

1 9 9 4 /1

1 9 9 2 /5

1 9 9 0 /9

1 9 8 9/1

1 9 8 7 /5

19 8 5 /9

1 9 8 4 /1

1 9 8 2 /5

1 9 8 0/9

1 9 7 9 /1

1 9 7 7/5

1 9 7 5 /9

1 9 7 4 /1

1 9 7 2/5

1 9 7 0 /9

1 9 69 /1

1 9 6 7 /5

1 9 6 5 /9

1 9 6 4 /1

Pattern IV: Cyclical

U.S. 3-Month Treasury Bill Rate

18.0

16.0

14.0

12.0

10.0

8.0

6.0

4.0

2.0

BoxJenkins Method
Assumption

In order to use the B/J method, the time

series should be stationary.

B/J main idea: Any stationary time series

can self-predict its own future from the
past data.

10
9
8
7
6
5
4
3
2
1
0
1

13

17

21

25

29

33

37

41

45

49

53

57

61

65

69

73

77

81

85

BoxJenkins Method
Assumption

We know that not all time series are

stationary.

However, it is easy to convert a trend or

a seasonal time series to a stationary
time series.

Simply use the concept of

Differencing.

Example of Differencing

Convert a trend time series to

stationary time series using the
differencing method

0.0

-2.0

2 0 03 /Q 1

2 0 02 /Q 2

2 0 01 /Q 3

2 0 00 /Q 4

2 0 00 /Q 1

1 9 99 /Q 2

1 9 98 /Q 3

1 9 97 /Q 4

1 9 97 /Q 1

1 9 9 6 /Q 2

4.0

1 9 9 5/Q 3

6.0

1 9 9 4 /Q 4

1 9 9 4/Q 1

1 9 9 3 /Q 2

1 9 9 2/Q 3

1 9 9 1 /Q 4

1 9 9 1/Q 1

1 9 9 0 /Q 2

series to stationary time

series
U.S. Electricity Consumption

12.0

10.0

8.0

d t Yt Yt 4

2.0

Differencing Summary

To convert trend time series to

stationary time series:

d t Yt Yt 1

To convert seasonal time series to

stationary time series:

d t Yt Yt 4

Both of the above two methods can be

applied/combined to remove the
cyclical effects.

How do we decide the

model?
Use Autocorrelation (AC) and Partial
Autocorrelation (PAC)
First-order autocorrelation is a measure of
how correlated an observation is with an
observation one period away, that is: (yt,yt1)
Second-order autocorrelation is a measure of
how correlated an observation is with an
observation two periods away (yt,yt2)
etc...

AR Model Fit
When the autocorrelation coefficients
gradually fall to 0, and the partial correlation
has spikes, an AR model is appropriate. The
order of the model depends on the number of
spikes.
An AR(2) model is shown below.

MA Model Fit
When the partial correlation coefficients
gradually fall to 0, and the autocorrelation has
spikes, a MA model is appropriate. The order
of the model depends on the number of
spikes.
An MA(1) model is shown below.

ARIMA Model Fit

When both the autocorrelation and the
partial correlograms show irregular patterns,
then an ARIMA model is appropriate. The
order of the model depends on the number
of spikes.
An ARIMA(1,0,1) model is shown below.

Chapter Summary
BoxJenkins models capture a wide variety
of time series patterns.
When faced with a complicated time series
that includes a combination of trend,
seasonal factor, cyclical, as well as random
fluctuations, use of the BoxJenkins is
appropriate.
This methodology for forecasting is an
iterative process that begins by assuming a
tentative pattern that is fitted to the data so
that error will be minimized.
The major assumption of the model is that
the data is stationary.

Chapter Summary (continued)

Differencing could be used to make the
data stationary.
In using the different models of BoxJenkins,
we depend on the autocorrelation (AC) and
partial autocorrelation (PAC) as diagnostic
tools.
Computer programs such as Minitab, and
SPSS provide all the analysis tools for using
the BoxJenkins.