1

Best Fitted Model to Forecast the Trade Balance of Malaysia

by
Lisawati Indah Binti Osman
Faculty of Computer Science & Mathematics
UiTM, 40450 Shah Alam, Selangor
lisawatiindah178@yahoo.com

ABSTRACT
The main purpose of this paper is to determine the best fitted model that will perform the forecast best in the case of
Malaysia trade balance. The data used in this study is obtained from the Department of Statistics, Malaysia. The
inclusion of five appropriate models in this study is purposely to examine the parameter values for comparison for
error measures. Models involved are based on the Univariate Modelling Techniques; Naive with Trend Model,
Single Exponential Smoothing, Double Exponential Smoothing, Holts Method Model and Adaptive Response Rate
Exponential Smoothing (ARRES). The best parameter value obtained in this study marked as the main indicator in
selecting the best fitted model; indicated by the smallest value of mean square error (MSE and MAPE). Based on the
analysis, Adaptive Response Rate Exponential Smoothing (ARRES) model is the most suitable model to forecast the
monthly Trade balance for Malaysia.
Keywords: Fitted Model, Forecast, Parameter Value, Univariate Modelling Techniques, MSE, MAPE
INTRODUCTION
The balance of trade is the difference between the monetary value of exports and imports in an economy over a
certain period of time. A positive balance of trade is known as a trade surplus and consists of exporting more than is
imported while a negative balance of trade is known as a trade deficit or, informally, a trade gap.
The balance of trade forms part of the current account for a particular country, which also includes other transactions
such as income from the international investment position as well as international aid. A surplus in current account
shows the country's net international asset position increases correspondingly. Equally, a deficit decreases the net
international asset position.
International trade plays a large role in Malaysian economy; a contributing factor to the economic gross for the
country. The international trade of Malaysia consists of wide range of products. Malaysia is one of the top exporters
of manufactured products; electrical and electronics, agriculture products; palm oil and other vegetables oil, mining
products; crude petroleum and other products as well. The country mainly imports: electronics, machinery,
petroleum products, plastics, vehicles, iron and steel products and chemicals. Malaysias main trading partners are
United States, European Union, Singapore, Japan and China.
This paper is divided into several sections; begins with the introduction, followed by objectives of the study and
methodology. In methodology section, five univariate forecasting models were evaluated to obtain the parameter
values. Furthermore, the evaluation and estimation procedure will be briefly described in the same section. The
section then continues with results & discussions and conclusion before end up with the references.
OBJECTIVE
The main objective highlighted in this study is to find the best fitted model that would perform the forecast best for
Malaysia trade balance. The criterion involved in the selection of best model should be cautiously defined and
evaluate to avoid wrong selection of forecasting models.
2


METHODOLOGY
The initial study of the data is crucial in determining the existence of trend, cyclical, seasonal and irregular
components; where possible these components need to be calculated and isolated. Cyclical variation in time series
data refer to the rises and falls of the series over unspecified period of time. The data with the cyclical component
will show a cyclical pattern that wind around the linear trend. Two methods used to identify the cyclical component;
Residual method and Relative Cyclical Residual Method. The formula is written as follow:
100

|
|
.
|

\
|
y
y
t
t
and
|
|
.
|

\
|

y
T
y
t
t t

, respectively.
The technique applied to analyze selected data obtained from the Department of Statistics of Malaysia is briefly
described in this section. A Univariate model is a method for analyzing data on a single variable at a time. The
application of single variable model in the study provides simplicity advantage. The models were fitted into the data
to obtain parameter value for comparison; main indicator for best model to predict future values of trade balance
based on past observations in a given time series.
Analysis was done using five types of forecast models, which is Naive with Trend Model, Single Exponential
Smoothing, Double Exponential Smoothing, Holts Method Model and Adaptive Response Rate Exponential
Smoothing (ARRES). The statistical test and data analysis were done through Microsoft Excel.
a. Naive with Trend Model
This model implies that all future forecasts can be set to equal the actual observed value in the most recent time
period multiplied by the growth rate. The trend value is measured by
y
y
t
t
1
, where
y
t
is the actual value at time t
and
y
t 1
is the actual value in the preceding period. If
y
t
is greater than
y
t 1
then the trend is upward and
conversely if
y
t
is less than
y
t 1
then the trend is downward. Therefore, the one-step-ahead forecast is
represented as,
Ft 1 +
=
y
t

y
y
t
t
1
.
This model is highly sensitive to the changes in the actual values. A sudden drop or sharp increase in the values will
severely affect the forecast. Furthermore, fitting this model type will result in the loss of the first two observations in
the series. On the other hand, this model is only suitable to be used for short time series.
b. Single Exponential Smoothing
It is a simplest form of model within the family of the exponential smoothing techniques. It requires only one
parameter, which is the smoothing constant, o . The general equation for single exponentially smoothed statistic is
given as,
F m t +
= o
y
t
+( ) o 1
Ft
, where
F m t +
is the single smoothed value in period m t + for
,....., 4 , 3 , 2 , 1 = m
y
t
is the actual value at time t , o represent smoothing constant ( ) 1 0 s s o ,
Ft
is the
forecast or smoothed value for period t .
3

There are several limitations for single exponential technique. It is best to be used in situation where data series has
no significant trend, no seasonality pattern and any other underlying pattern. Furthermore, any forecast value
generated beyond one step ahead is the same to the value of one-step-ahead forecast.
c. Double Exponential Smoothing
This technique is also known as Browns method. It is useful for series that exhibit a linear trend characteristic. The
following notations are used:
Let,
st
be the exponentially smoothed value of
y
t
at time t and
s t
'
be the double exponentially smoothed value
of
y
t
at time t . Generally, there are four equations involved.
Equation 1: Computes the single exponentially smoothed value
( )
s
y
s t
t
t 1
1

+ = o o
Equation 2: Computes the double exponentially smoothed value
s t
'
= ( )
s s t t 1
1

+ o o
Equation 3: Computes the difference between the exponentially smoothed values
'
2 S S a
t t
=

Equation 4: Computes the adjustment factor

) (
1
'
t t t
S S b

=
o
o

Forecasting for m-step-ahead are computed using the equation

m b a F
t t m t
+ =
+

where
1 + t
F is the m-step-ahead forecast at period m made in period t for ... 3 , 2 , 1 = m
The main advantage of the double exponential smoothing method over single exponential is its ability to generate
the one, two, three and so forth ahead-forecast values but this model difficult to determine the size of o . The
criterion is to choose o such that the MSE is minimum. However, it can be ease by using solver in Microsoft
excel to find the best parameter o value.
d. Holts Method

Holts Method is a technique that takes into account to smooth the trend and the slope directly by using different
smoothing constants. It also provides more flexibility in selecting the parameter value which the trend and slopes are
tracked. Holts Method consists of three basic equations that define the exponential smoothed series and the trend
estimate. The Holts Method equations are represented as follows:
Exponentially smoothed series:
( )( )
T s
y
s t t
t
t 1 1
1

+ + = o o
Trend estimate:
( ) ( )
T s s T t t t t 1 1
1

+ = | |
Therefore, the one-step-ahead forecast is:
4

( ) 1
1 T s F t t t
+ =
+

Where,
st
= exponentially smoothed series,
y
t
= actual values,
Tt
= trend estimate
o = smoothing constant ( ) 1 0 s s o and | = smoothing constant for the trend estimate ( ) 1 0 s s |
e. Adaptive Response Rate Exponential Smoothing (ARRES)
ARRES technique is incorporating the effect of the changing pattern of the data series into the model. It comprises
of the following basic equation. For the one-step-ahead forecast;
( )
F
y
F t
t
t t
o
o
+ =
+
1
1

The values of
AE
E
t
t
t
=
o
where, ( )
E e E t t t 1
1

+ = | | ; 1 0 s s | , ( )( )
AE e AE t t t 1
1

+ = | |
and that,
F
y
e t
t
t
=
The value of
Et
is defined as the smoothed average error, and
AEt
is the smoothed absolute error. In the
application of this model, there is no best value for o because there is no single best o value which happens to
vary overtime.
Initial Values of the Model
As any exponential smoothing technique, ARRES model requires the appropriate initial values to start the algorithm.
In this case, values are for
F0
,
o0
, ,
0 E
and
AE0
.
First, the arbitrary values for 1 . 0 = o and 6 . 0 = | were selected and that the initial value for the estimate for
M1,2008,
F1
, be equal to the actual for M1,2008,
y
1
; in other words,
y
F
1
1
= . This means that error,
e0
is
set to zero and that the initial values for ,
0 E
and
AE0
are also set to zero. Note that the value of o must not
exceed 1. Different values of o and | were experiment to see the differences in the results. Solver application is
also used to determine the optimum initial values.
Estimation and Evaluation Procedures
Basically, there are three stages involved in this procedure:
i. In the first stage, the data series is divided into two parts. The first part is called model estimation part (or
fitted part) and the second part is the evaluation part (or holdout part), which will be used to evaluate the
models forecasting performance;
ii. In the estimation part, the five models were fitted into the data. The minimum value of o and | are
determined by Solver facility available in Microsoft Excel which derived parameter values from data
series for the related models. The model with the smallest MSE will be selected in this part.
iii. In the evaluation part, the process in stage two was repeated again but this time, each model was compared
based on the MSE and MAPE value. The model with the smallest MSE and MAPE value will be selected
as the best fitted model for forecasting.
RESULTS AND DISCUSSION
5

Univariate forecasting model was used to predict trade balance for the first month of year 2011 in Malaysia. The
estimation was done by using data from first month of 2008 to the third month of 2010, while remaining
observations from the fourth month of 2010 to the twelfth month of 2010 were used to evaluate model forecasting
performance. Malaysia trade balance (Billion) for the period of study from the first month of 2008 to the twelfth
month of 2010 is shown in Table 1(refer to Appendices).
The initial study of the data is crucial in determining the existence of trend, cyclical, seasonal and irregular
components. Base on the figure 1 below, the data shows the existence of the cyclical component since it shows a
cyclical pattern that wind around the linear trend.
Figure 1 shows the graph and the trend line of the trade balance from the first month of 2008 to the twelfth month of
2010. Values of trade balance indicate a maximum increase during the third to fifth month of 2008, with 15.47590
billions, before it begins to decrease and increase steadily until the third month of 2010. The trade balance then
experience a steep decrease during the third to sixth month of 2010 with 14.32700,9.25490 8.12790 and 6.04320
(billions) respectively before continuing to fluctuates back until the end of 2010.The overall trend line equation for
quarterly data is given by 21 . 12 104 . 0 + = x y . The trend line indicates that the underlying pattern of the data
follows a relatively stable downward trend.


Univariate Modelling Techniques
The estimations were done with the objective of minimizing MSE and MAPE for both in the estimation and
evaluation part. Graphs for each model and results of the corresponding MSE and MAPE value for each model are
shown below.
i. Naive with Trend Model
0.00000
5.00000
10.00000
15.00000
20.00000
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112
2008 2009 2010
Balance of Trade (Billion) Linear (Balance of Trade (Billion))
Figure 1: Monthly Balance Trade, Malaysia, M1,2008-M12,2010
6





ERROR MEASUREMENT MSE MAPE
Evaluation Period: (M4,2010-M12,2010) 18.03227 0.667862
Evaluation Period: (M4,2010-M12,2010) 11.16991 1.241101

ii. Single Exponential Smoothing
Computation of the minimum value of was determined by solver facility available in Microsoft Excel. Based on
the solver result, the best to use is 0.530030776 since it minimizes the error measure.



ERROR MEASUREMENT MSE MAPE
Evaluation Period: (M4,2010-M12,2010) 4.901155 16.19106
Evaluation Period: (M4,2010-M12,2010) 4.940316 23.85486

iii. Double Exponential Smoothing
0.00000
5.00000
10.00000
15.00000
20.00000
25.00000
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112
2008 2009 2010
Balance of Trade (Billion) t
0.00000
5.00000
10.00000
15.00000
20.00000
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112
2008 2009 2010
Balance of Trade (Billion) t
Figure 2: Fitted Naive with Trend Model, Malaysia, M1,2008-M12,2010
Figure 3: Fitted Single Exponential Smoothing Model, Malaysia, M1,2008-M12,2010
Table 3: MSE and MAPE for Nave with Trend Model
Table 4: MSE and MAPE for Single Exponential Smoothing Model
7

Computation of the minimum value of was determined by solver facility available in Microsoft Excel. Based on
the solver result, the best to use is 0.5 since it minimizes the error measure.



ERROR MEASUREMENT MSE MAPE
Evaluation Period: (M4,2010-M12,2010) 4.881479 16.06991
Evaluation Period: (M4,2010-M12,2010) 5.017339 24.28515

iv. Holts Method Model
Like previous model, the computation of the minimum value of and was determined by solver facility available
in Microsoft Excel. Based on the solver result, the best = 0.530030776, = 0.1since it minimizes the error measure.



ERROR MEASUREMENT MSE MAPE
Evaluation Period: (M4,2010-M12,2010) 5.199978 16.67829
Evaluation Period: (M4,2010-M12,2010) 5.798515 24.20127

0.00000
5.00000
10.00000
15.00000
20.00000
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112
2008 2009 2010
Balance of Trade (Billion) t
0.00000
5.00000
10.00000
15.00000
20.00000
1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112
2008 2009 2010
Balance of Trade (Billion) t
Figure 4: Fitted Double Exponential Smoothing Model, Malaysia, M1,2008-M12,2010
Figure 5: Fitted Holt Method Model, Malaysia, M1,2008-M12,2010
Table 5: MSE and MAPE for Double Exponential Smoothing Model
Table 6: MSE and MAPE for Holts Model
8

v. Adaptive Response Rate Exponential Smoothing (ARRES)
There is an exceptional case for ARRES model, where there is no best parameter estimate. Therefore, the
computational of the minimum value of and was determined by solver facility available in Microsoft Excel.
Based on the solver result, = 0.1, = 0.6 will be the optimum initial values.



ERROR MEASUREMENT MSE MAPE
Evaluation Period: (M4,2010-M12,2010) 4.8871271 17.578405
Evaluation Period: (M4,2010-M12,2010) 4.7886913 22.571628

Error comparison and model selection
Table 8 presents the summaries and comparison on MSE figures for ; Naive with Trend Model, Single Exponential
Smoothing, Double Exponential Smoothing, Holts Method Model and Adaptive Response Rate Exponential
Smoothing (ARRES). Based only on the MSE value calculated over the fitted period, it can be concluded that the
most suitable model to forecast the balance trade is Double Exponential Smoothing Method with = 0.5 since it has
the smallest value of MSE compared to other forecasting techniques.



Model Types


Time Series
Error
Measures
Naive with
trend
method

Single
Exponential
Smoothing
=
0.530030776
Double
Exponential
Smoothing
= 0.5
Holts Model
=
0.530030776,
= 0.1
ARRES
= 0.1, = 0.6
Estimation Period:
(M1:2008-M3:2010)
MSE 18.03227 4.90116 4.88148 5.19998 4.88713

0.00000
2.00000
4.00000
6.00000
8.00000
10.00000
12.00000
14.00000
16.00000
18.00000
1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1
2008 2009 2010 2011
Balance of Trade (Billion) t Forecast
Figure 6: Fitted Adaptive Response Rate Exponential Smoothing (ARRES), Malaysia, M1,2008-M12,2010
Table 7: MSE and MAPE for Adaptive Rate Exponential Smoothing (ARRES) Model
Table 8: MSE Value comparison for each model
9

Table 9 presents the summaries and comparison on MSE and MAPE figures for ; Naive with Trend Model, Single
Exponential Smoothing, Double Exponential Smoothing, Holts Method Model and Adaptive Response Rate
Exponential Smoothing (ARRES). Based on the MSE value calculated over the evaluation period, it can be
concluded that the most suitable model to forecast the balance trade is ARRES method with = 0.1 and = 0.6
since it has the smallest value of MSE compared to other forecasting techniques.




Model Types
Time Series
Error
Measures
Naive with
trend
method

Single
Exponential
Smoothing
=
0.530030776
Double
Exponential
Smoothing
= 0.5
Holts Model
=
0.530030776,
= 0.1
ARRES
= 0.1, = 0.6
Evaluation Period:
(M4:2010-M1:2010)
MSE 11.16991 4.94032 5.02913 5.79852 4.78869
MAPE 30.54878 23.85486 24.31383 24.20127 22.57164


CONCLUSION
Based on the one-step-ahead forecast analysis, Adaptive Response Rate Exponential Smoothing (ARRES) model is
the most suitable model to forecast Malaysia monthly trade balance. This is because; Based on the evaluation part
the model shows the smallest MSE and MAPE value; 4.78869 and 22.57164 respectively. The model forecasted the
trade balance to reach 9.536881243 billion for the first month of 2011.
Univariate Modelling Techniques are basically single variable models that use their past information as the basis to
generate the forecast values. This is made on the assumption that the forecast values are dependent solely on the past
pattern of the data series. However, in forecasting for longer term, it is less statistically fit than the one-step-ahead
forecast because the more recent data may depart from the previous underlying process.

International trade plays a large role in Malaysian economy; a contributing factor to the economic gross for the
country. Therefore, the forecasting of balance trade should become one of the major fields of research in recent
years to provide any particular country with the clear picture of their performance in terms of economic sector. .

REFERENCES
Malaysia Export By Products Statistics 2001 (January), n.d retrieved October 15, 2011, from http://e-
directory.com.my/doc/info-export%20by%20products.htm
Lazim, M. A. (2011). Introductory Business Forecasting A Practical Approach. Third edition, University
Publication Center (UPENA), Universiti Teknologi Mara, Shah Alam.
Liang, H. S et.all. Real Exchange Rate and Trade Balance Relationship: An Empirical Study on Malaysia. Vol. 3,
No. 8.
Fengbao Y. et.all. The Sustainability of Trade Balances in China. Kobe University.Volume 31, Issue 3

M. Faruk Aydn, et.all, Export Supply and Import Demand Models for the Turkish Economy, No:04/9

Falk, M.Determinants of the Trade Balance in Industrialized Countries, 2008
Table 9: MSE and MAPE Value comparison for each model