Question 13.57

13.57 Moving averages and linear trend.

The moving-average model provides reasonable predictions only under certain scenarios. Consider monthly seasonally adjusted Consumer Price Index (CPI) data, starting with January 1990 and ending in July 2014.32

cpi

  1. Make a time plot of the CPI series. Describe its movement over time.
  2. Using software, calculate moving average forecasts for spans of and 100. Superimpose the moving averages (on a single time plot) on a plot of the original time series.
  3. As the span increases, what do you observe about the plot of the moving averages?
  4. At the stock market analysis website stockcharts.com, it is stated that moving averages “are best suited for trend identification and trend following purposes, not for prediction.” Explain whether or not your results from part (a) are consistent with this claim.

13.57

(a) The CPI series is steadily increasing over time. (c) The plot gets smoother with a larger span. (d) The results are consistent with the quote. Both moving average predictions would grossly underestimate the CPI values. However, they do show the general pattern, or upward trend, of the CPI data.