forecasting usingtime-relationships in data. 2 standard errors of coefficients are incorrect ......

Forecasting using

11. Dynamic regression

OTexts.com/fpp/9/1/

Forecasting using R 1

Rob J Hyndman

Outline

1 Regression with ARIMA errors

2 Example: Japanese cars

3 Using Fourier terms for seasonality

4 Example: Sales of petroleum & coalproducts

Forecasting using R Regression with ARIMA errors 2

Regression with ARIMA errors

Regression modelsyt = b0 + b1x1,t + · · ·+ bkxk,t + nt

yt modeled as function of k explanatoryvariables x1,t, . . . , xk,t.Usually, we assume that nt is WN.Now we want to allow nt to be autocorrelated.

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

and et is white noise .

Forecasting using R Regression with ARIMA errors 3

Regression with ARIMA errors

Regression modelsyt = b0 + b1x1,t + · · ·+ bkxk,t + nt

yt modeled as function of k explanatoryvariables x1,t, . . . , xk,t.Usually, we assume that nt is WN.Now we want to allow nt to be autocorrelated.

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

and et is white noise .

Forecasting using R Regression with ARIMA errors 3

Regression with ARIMA errors

Regression modelsyt = b0 + b1x1,t + · · ·+ bkxk,t + nt

yt modeled as function of k explanatoryvariables x1,t, . . . , xk,t.Usually, we assume that nt is WN.Now we want to allow nt to be autocorrelated.

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

and et is white noise .

Forecasting using R Regression with ARIMA errors 3

Regression with ARIMA errors

Regression modelsyt = b0 + b1x1,t + · · ·+ bkxk,t + nt

yt modeled as function of k explanatoryvariables x1,t, . . . , xk,t.Usually, we assume that nt is WN.Now we want to allow nt to be autocorrelated.

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

and et is white noise .

Forecasting using R Regression with ARIMA errors 3

Regression with ARIMA errors

Regression modelsyt = b0 + b1x1,t + · · ·+ bkxk,t + nt

yt modeled as function of k explanatoryvariables x1,t, . . . , xk,t.Usually, we assume that nt is WN.Now we want to allow nt to be autocorrelated.

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

and et is white noise .

Forecasting using R Regression with ARIMA errors 3

Residuals and errors

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

Be careful in distinguishing nt from et.nt are the “errors” and et are the “residuals”.In ordinary regression, nt is assumed to bewhite noise and so nt = et.

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

Now a regression with ARMA(1,1) error

Forecasting using R Regression with ARIMA errors 4

Residuals and errors

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

Be careful in distinguishing nt from et.nt are the “errors” and et are the “residuals”.In ordinary regression, nt is assumed to bewhite noise and so nt = et.

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

Now a regression with ARMA(1,1) error

Forecasting using R Regression with ARIMA errors 4

Residuals and errors

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

Be careful in distinguishing nt from et.nt are the “errors” and et are the “residuals”.In ordinary regression, nt is assumed to bewhite noise and so nt = et.

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

Now a regression with ARMA(1,1) error

Forecasting using R Regression with ARIMA errors 4

Residuals and errors

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

Be careful in distinguishing nt from et.nt are the “errors” and et are the “residuals”.In ordinary regression, nt is assumed to bewhite noise and so nt = et.

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

Now a regression with ARMA(1,1) error

Forecasting using R Regression with ARIMA errors 4

Residuals and errors

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

Be careful in distinguishing nt from et.nt are the “errors” and et are the “residuals”.In ordinary regression, nt is assumed to bewhite noise and so nt = et.

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

Now a regression with ARMA(1,1) error

Forecasting using R Regression with ARIMA errors 4

Residuals and errors

Example: nt = ARIMA(1,1,1)

yt = b0 + b1x1,t + · · ·+ bkxk,t + ntwhere (1− φ1B)(1− B)nt = (1− θ1B)et

Be careful in distinguishing nt from et.nt are the “errors” and et are the “residuals”.In ordinary regression, nt is assumed to bewhite noise and so nt = et.

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

Now a regression with ARMA(1,1) error

Forecasting using R Regression with ARIMA errors 4

Regression with ARIMA errorsAny regression with an ARIMA error can be rewrittenas a regression with an ARMA error by differencingall variables with the same differencing operator asin the ARIMA model.

Original data

yt = b0 + b1x1,t + · · ·+ bkxk,t + nt

where φ(B)(1− B)dnt = θ(B)et

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

where φ(B)nt = θ(B)et

and y′t = (1− B)dyt, etc.Forecasting using R Regression with ARIMA errors 5

Regression with ARIMA errorsAny regression with an ARIMA error can be rewrittenas a regression with an ARMA error by differencingall variables with the same differencing operator asin the ARIMA model.

Original data

yt = b0 + b1x1,t + · · ·+ bkxk,t + nt

where φ(B)(1− B)dnt = θ(B)et

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

where φ(B)nt = θ(B)et

and y′t = (1− B)dyt, etc.Forecasting using R Regression with ARIMA errors 5

Regression with ARIMA errorsAny regression with an ARIMA error can be rewrittenas a regression with an ARMA error by differencingall variables with the same differencing operator asin the ARIMA model.

Original data

yt = b0 + b1x1,t + · · ·+ bkxk,t + nt

where φ(B)(1− B)dnt = θ(B)et

After differencing all variables

y′t = b1x′1,t + · · ·+ bkx

′k,t + n′t.

where φ(B)nt = θ(B)et

and y′t = (1− B)dyt, etc.Forecasting using R Regression with ARIMA errors 5

Modeling procedureProblems with OLS and autocorrelated errors

1 OLS no longer the best way to computecoefficients as it does not take account oftime-relationships in data.

2 Standard errors of coefficients are incorrect —most likely too small. This invalidates tests andprediction intervals.

Second problem more serious because it can lead tomisleading results.If standard errors obtained using OLS too small, someexplanatory variables may appear to be significant when,in fact, they are not. This is known as “spuriousregression.”

Forecasting using R Regression with ARIMA errors 6

Modeling procedureProblems with OLS and autocorrelated errors

1 OLS no longer the best way to computecoefficients as it does not take account oftime-relationships in data.

2 Standard errors of coefficients are incorrect —most likely too small. This invalidates tests andprediction intervals.

Second problem more serious because it can lead tomisleading results.If standard errors obtained using OLS too small, someexplanatory variables may appear to be significant when,in fact, they are not. This is known as “spuriousregression.”

Forecasting using R Regression with ARIMA errors 6

Modeling procedureProblems with OLS and autocorrelated errors

1 OLS no longer the best way to computecoefficients as it does not take account oftime-relationships in data.

2 Standard errors of coefficients are incorrect —most likely too small. This invalidates tests andprediction intervals.

Second problem more serious because it can lead tomisleading results.If standard errors obtained using OLS too small, someexplanatory variables may appear to be significant when,in fact, they are not. This is known as “spuriousregression.”

Forecasting using R Regression with ARIMA errors 6

Modeling procedureProblems with OLS and autocorrelated errors

1 OLS no longer the best way to computecoefficients as it does not take account oftime-relationships in data.

2 Standard errors of coefficients are incorrect —most likely too small. This invalidates tests andprediction intervals.

Second problem more serious because it can lead tomisleading results.If standard errors obtained using OLS too small, someexplanatory variables may appear to be significant when,in fact, they are not. This is known as “spuriousregression.”

Forecasting using R Regression with ARIMA errors 6

Modeling procedureProblems with OLS and autocorrelated errors

1 OLS no longer the best way to computecoefficients as it does not take account oftime-relationships in data.

2 Standard errors of coefficients are incorrect —most likely too small. This invalidates tests andprediction intervals.

Second problem more serious because it can lead tomisleading results.If standard errors obtained using OLS too small, someexplanatory variables may appear to be significant when,in fact, they are not. This is known as “spuriousregression.”

Forecasting using R Regression with ARIMA errors 6

Modeling procedure

Estimation only works when all predictorvariables are deterministic or stationary andthe errors are stationary.

So difference stochastic variables as requireduntil all variables appear stationary. Then fitmodel with ARMA errors.

auto.arima() will handle order selection anddifferencing (but only checks that errors arestationary).

Forecasting using R Regression with ARIMA errors 7

Modeling procedure

Estimation only works when all predictorvariables are deterministic or stationary andthe errors are stationary.

So difference stochastic variables as requireduntil all variables appear stationary. Then fitmodel with ARMA errors.

auto.arima() will handle order selection anddifferencing (but only checks that errors arestationary).

Forecasting using R Regression with ARIMA errors 7

Modeling procedure

Estimation only works when all predictorvariables are deterministic or stationary andthe errors are stationary.

So difference stochastic variables as requireduntil all variables appear stationary. Then fitmodel with ARMA errors.

auto.arima() will handle order selection anddifferencing (but only checks that errors arestationary).

Forecasting using R Regression with ARIMA errors 7

Outline

1 Regression with ARIMA errors

2 Example: Japanese cars

3 Using Fourier terms for seasonality

4 Example: Sales of petroleum & coalproducts

Forecasting using R Example: Japanese cars 8

Example: Japanese cars

Forecasting using R Example: Japanese cars 9

Japanese motor vehicle production

Year

mill

ions

1965 1970 1975 1980 1985 1990

24

68

1012

Example: Japanese cars

Forecasting using R Example: Japanese cars 9

Japanese motor vehicle production

Year

mill

ions

1965 1970 1975 1980 1985 1990

24

68

1012

Proposed model:linear trend pluscorrelated errors.yt = a + bt + ntwhere nt is ARMAprocess.

Example: Japanese cars

Forecasting using R Example: Japanese cars 10

Errors from linear trend model

1965 1970 1975 1980 1985 1990

−0.

50.

51.

01.

5

●

●●

●

●

●

●● ●

●

●●

●

●

●

●

●

●

●

●

●

●

●

● ●

●

2 4 6 8 10 12 14

−0.

6−

0.2

0.2

0.6

Lag

AC

F

2 4 6 8 10 12 14

−0.

6−

0.2

0.2

0.6

Lag

PAC

F

Example: Japanese cars

1 We will fit a linear trend model:

yt = a + bxt + nt

where xt = t − 1963.

2 auto.arima chooses an AR(1) model for nt.

3 Full model is

yt = a + bxt + nt where nt = φ1nt−1 + et

and et is a white noise series.

Forecasting using R Example: Japanese cars 11

Example: Japanese cars

1 We will fit a linear trend model:

yt = a + bxt + nt

where xt = t − 1963.

2 auto.arima chooses an AR(1) model for nt.

3 Full model is

yt = a + bxt + nt where nt = φ1nt−1 + et

and et is a white noise series.

Forecasting using R Example: Japanese cars 11

Example: Japanese cars

1 We will fit a linear trend model:

yt = a + bxt + nt

where xt = t − 1963.

2 auto.arima chooses an AR(1) model for nt.

3 Full model is

yt = a + bxt + nt where nt = φ1nt−1 + et

and et is a white noise series.

Forecasting using R Example: Japanese cars 11

Example: Japanese cars

Parameter Estimate StandardError

AR(1) φ1 0.736 0.152Intercept a 1662. 504.1Slope b 463.6 32.31

We need to check that the residuals (et) looklike white noise.

Forecasting using R Example: Japanese cars 12

Example: Japanese cars

Parameter Estimate StandardError

AR(1) φ1 0.736 0.152Intercept a 1662. 504.1Slope b 463.6 32.31

We need to check that the residuals (et) looklike white noise.

Forecasting using R Example: Japanese cars 12

Example: Japanese cars

Forecasting using R Example: Japanese cars 13

Residuals from linear trend + AR(1) model

1965 1970 1975 1980 1985 1990

−0.

50.

00.

51.

0

●

●

●

●

●

●●

● ●

●

●

●

●

●

●

●

●

●

●

●●

●

●

●

●

●

2 4 6 8 10 12 14

−0.

6−

0.2

0.2

0.6

Lag

AC

F

2 4 6 8 10 12 14

−0.

6−

0.2

0.2

0.6

Lag

PAC

F

Example: Japanese cars

Forecasting using R Example: Japanese cars 14

Forecasts from linear trend + AR(1) errors

mill

ions

1965 1970 1975 1980 1985 1990 1995 2000

510

1520

Example: Japanese cars

> fit2 <- auto.arima(x)ARIMA(0,1,0) with drift

Coefficients:drift0.4530

s.e. 0.0836

sigma^2 estimated as 0.1749:log likelihood = -13.68AIC = 31.36 AICc = 31.9 BIC = 33.8

Forecasting using R Example: Japanese cars 15

Example: Japanese cars

Forecasting using R Example: Japanese cars 16

Forecasts from ARIMA(0,1,0) with drift

mill

ions

1965 1970 1975 1980 1985 1990 1995 2000

510

1520

Example: Japanese cars

Forecasting using R Example: Japanese cars 16

Forecasts from linear trend + AR(1) errors

mill

ions

1965 1970 1975 1980 1985 1990 1995 2000

510

1520

Outline

1 Regression with ARIMA errors

2 Example: Japanese cars

3 Using Fourier terms for seasonality

4 Example: Sales of petroleum & coalproducts

Forecasting using R Using Fourier terms for seasonality 17

Fourier series

Any periodic function of period m can beapproximated using

K∑k=1

{sin

(2πkt

m

)+ cos

(2πkt

m

)}The approximation can be made exact withlarge K.

Each k represents a harmonic.

fourier generates a matrix of Fourier terms.

Examplefit <- auto.arima(y, seasonal=FALSE,

xreg=fourier(y, K=3))

Forecasting using R Using Fourier terms for seasonality 18

Fourier series

Any periodic function of period m can beapproximated using

K∑k=1

{sin

(2πkt

m

)+ cos

(2πkt

m

)}The approximation can be made exact withlarge K.

Each k represents a harmonic.

fourier generates a matrix of Fourier terms.

Examplefit <- auto.arima(y, seasonal=FALSE,

xreg=fourier(y, K=3))

Forecasting using R Using Fourier terms for seasonality 18

Fourier series

Any periodic function of period m can beapproximated using

K∑k=1

{sin

(2πkt

m

)+ cos

(2πkt

m

)}The approximation can be made exact withlarge K.

Each k represents a harmonic.

fourier generates a matrix of Fourier terms.

Examplefit <- auto.arima(y, seasonal=FALSE,

xreg=fourier(y, K=3))

Forecasting using R Using Fourier terms for seasonality 18

Fourier series

Any periodic function of period m can beapproximated using

K∑k=1

{sin

(2πkt

m

)+ cos

(2πkt

m

)}The approximation can be made exact withlarge K.

Each k represents a harmonic.

fourier generates a matrix of Fourier terms.

Examplefit <- auto.arima(y, seasonal=FALSE,

xreg=fourier(y, K=3))

Forecasting using R Using Fourier terms for seasonality 18

Fourier series

Any periodic function of period m can beapproximated using

K∑k=1

{sin

(2πkt

m

)+ cos

(2πkt

m

)}The approximation can be made exact withlarge K.

Each k represents a harmonic.

fourier generates a matrix of Fourier terms.

Examplefit <- auto.arima(y, seasonal=FALSE,

xreg=fourier(y, K=3))

Forecasting using R Using Fourier terms for seasonality 18

Outline

1 Regression with ARIMA errors

2 Example: Japanese cars

3 Using Fourier terms for seasonality

4 Example: Sales of petroleum & coalproducts

Forecasting using R Example: Sales of petroleum & coal products 19

Example: Sales of petroleum & coal products

U.S. monthly sales: Jan 1971 – Dec 1991.Forecasting using R Example: Sales of petroleum & coal products 20

Sales: Petroleum and coal products

1975 1980 1985 1990

510

1520

Sales: Chemicals and allied products

1975 1980 1985 1990

510

1520

25

Bituminous Coal production

1975 1980 1985 1990

2040

6080

Sales: Motor Vehicles and parts

1975 1980 1985 1990

510

1520

Example: Sales of petroleum & coal products

Forecasting using R Example: Sales of petroleum & coal products 21

Log Sales: Petroleum & Coal products

1975 1980 1985 1990

1.0

1.5

2.0

2.5

3.0

Log Sales: Chemicals & allied products

1975 1980 1985 1990

1.5

2.0

2.5

3.0

Log Bituminous Coal production

1975 1980 1985 1990

2.5

3.0

3.5

4.0

4.5

Log Sales: Motor Vehicles and parts

1975 1980 1985 1990

1.5

2.0

2.5

3.0

Example: Sales of petroleum & coal products

Series clearly non-stationary, so difference.

Forecasting using R Example: Sales of petroleum & coal products 21

Log Sales: Petroleum & Coal products

1975 1980 1985 1990

1.0

1.5

2.0

2.5

3.0

Log Sales: Chemicals & allied products

1975 1980 1985 1990

1.5

2.0

2.5

3.0

Log Bituminous Coal production

1975 1980 1985 1990

2.5

3.0

3.5

4.0

4.5

Log Sales: Motor Vehicles and parts

1975 1980 1985 1990

1.5

2.0

2.5

3.0

Example: Sales of petroleum & coal products

y′t = b1x′1,t + b2x

′2,t + b3x

′3,t + nt

yt = log petroleum sales

x1,t = log chemical sales

x2,t = log coal production

x3,t = log motor vehicle and parts sales.

auto.arima selects an ARIMA(0,0,1)(1,0,2)12

model for nt.Full model is yt = b1x1,t + b2x2,t + b3x3,t + nt

(1−Φ1B12)(1−B)nt = (1+θ1B)(1+Θ1B

12+Θ2B24)et.

Forecasting using R Example: Sales of petroleum & coal products 22

Example: Sales of petroleum & coal products

y′t = b1x′1,t + b2x

′2,t + b3x

′3,t + nt

yt = log petroleum sales

x1,t = log chemical sales

x2,t = log coal production

x3,t = log motor vehicle and parts sales.

auto.arima selects an ARIMA(0,0,1)(1,0,2)12

model for nt.Full model is yt = b1x1,t + b2x2,t + b3x3,t + nt

(1−Φ1B12)(1−B)nt = (1+θ1B)(1+Θ1B

12+Θ2B24)et.

Forecasting using R Example: Sales of petroleum & coal products 22

Example: Sales of petroleum & coal products

y′t = b1x′1,t + b2x

′2,t + b3x

′3,t + nt

yt = log petroleum sales

x1,t = log chemical sales

x2,t = log coal production

x3,t = log motor vehicle and parts sales.

auto.arima selects an ARIMA(0,0,1)(1,0,2)12

model for nt.Full model is yt = b1x1,t + b2x2,t + b3x3,t + nt

(1−Φ1B12)(1−B)nt = (1+θ1B)(1+Θ1B

12+Θ2B24)et.

Forecasting using R Example: Sales of petroleum & coal products 22

Example: Sales of petroleum & coal products

Parameter Estimate S.EMA(1) θ1 0.331 0.058Seasonal AR(1) Φ1 0.916 0.053Seasonal MA(1) Θ1 −0.661 0.086Seasonal MA(2) Θ2 −0.116 0.068Log Chemicals b1 0.296 0.065Log Coal b2 -0.029 0.013Log Vehicles b3 -0.014 0.023

AIC = −913.8Consider dropping motor vehicles and partsvariable: AIC= −915.6.

Forecasting using R Example: Sales of petroleum & coal products 23

Example: Sales of petroleum & coal products

Parameter Estimate S.EMA(1) θ1 0.331 0.058Seasonal AR(1) Φ1 0.916 0.053Seasonal MA(1) Θ1 −0.661 0.086Seasonal MA(2) Θ2 −0.116 0.068Log Chemicals b1 0.296 0.065Log Coal b2 -0.029 0.013Log Vehicles b3 -0.014 0.023

AIC = −913.8Consider dropping motor vehicles and partsvariable: AIC= −915.6.

Forecasting using R Example: Sales of petroleum & coal products 23

Forecasting

To forecast a regression model with ARIMAerrors, we need to forecast the regression partof the model and the ARIMA part of the modeland combine the results.When future predictors are unknown, theyneed to be forecast first.Forecasts of macroeconomic variables may beobtained from the national statistical offices.Separate forecasting models may be neededfor other explanatory variables.Some explanatory variable are known into thefuture (e.g., time, dummies).

Forecasting using R Example: Sales of petroleum & coal products 24

Forecasting

To forecast a regression model with ARIMAerrors, we need to forecast the regression partof the model and the ARIMA part of the modeland combine the results.When future predictors are unknown, theyneed to be forecast first.Forecasts of macroeconomic variables may beobtained from the national statistical offices.Separate forecasting models may be neededfor other explanatory variables.Some explanatory variable are known into thefuture (e.g., time, dummies).

Forecasting using R Example: Sales of petroleum & coal products 24

Forecasting

To forecast a regression model with ARIMAerrors, we need to forecast the regression partof the model and the ARIMA part of the modeland combine the results.When future predictors are unknown, theyneed to be forecast first.Forecasts of macroeconomic variables may beobtained from the national statistical offices.Separate forecasting models may be neededfor other explanatory variables.Some explanatory variable are known into thefuture (e.g., time, dummies).

Forecasting using R Example: Sales of petroleum & coal products 24

Forecasting

To forecast a regression model with ARIMAerrors, we need to forecast the regression partof the model and the ARIMA part of the modeland combine the results.When future predictors are unknown, theyneed to be forecast first.Forecasts of macroeconomic variables may beobtained from the national statistical offices.Separate forecasting models may be neededfor other explanatory variables.Some explanatory variable are known into thefuture (e.g., time, dummies).

Forecasting using R Example: Sales of petroleum & coal products 24

Forecasting

To forecast a regression model with ARIMAerrors, we need to forecast the regression partof the model and the ARIMA part of the modeland combine the results.When future predictors are unknown, theyneed to be forecast first.Forecasts of macroeconomic variables may beobtained from the national statistical offices.Separate forecasting models may be neededfor other explanatory variables.Some explanatory variable are known into thefuture (e.g., time, dummies).

Forecasting using R Example: Sales of petroleum & coal products 24