The Olve Problem and Applications: Chapter 7- problem 12 and chapter 8-problem 4
To represent categorical variables, we use dummy variable to make it easier for a forecasting model. Assume that in order to include seasonality into the model, months will need to be used as dummy data.
First , the month variable needs to be split into four distinct categories – winter (January-March) , spring (April-June) , summer (July-September) and fall (October-December). Each of the subgroups will have a 0 or 1, depending on whether it applies to a given month.
For example , January will correspond to a value of 1 in the “winter” category while all other months will have 0 indicating their respective non-inclusion on that list. The process is repeated until all categories are represented accurately.
In order to ensure that projections are accurate, it is important to check dummy data against the actual trends of previous quarters. Additional factors, such as the market or other external influences, may be needed to refine forecasts.
The introduction of dummy factors into a model for regression helps to capture information about seasonality, which allows the organization to predict sales with more precision. By incorporating these features into the analysis, firms can gain greater insight about behavior expected over specific time periods. This allows them to make better decisions when planning for future operations.