Article

Data Mining and Knowledge Discovery

, Volume 4, Issue 4, pp 251-280

First online:

Discovering Interesting Patterns for Investment Decision Making with GLOWER ☹—A Genetic Learner Overlaid with Entropy Reduction

  • Vasant DharAffiliated withStern School of Business, New York University
  • , Dashin ChouAffiliated withStern School of Business, New York University
  • , Foster ProvostAffiliated withStern School of Business, New York University

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Abstract

Prediction in financial domains is notoriously difficult for a number of reasons. First, theories tend to be weak or non-existent, which makes problem formulation open ended by forcing us to consider a large number of independent variables and thereby increasing the dimensionality of the search space. Second, the weak relationships among variables tend to be nonlinear, and may hold only in limited areas of the search space. Third, in financial practice, where analysts conduct extensive manual analysis of historically well performing indicators, a key is to find the hidden interactions among variables that perform well in combination. Unfortunately, these are exactly the patterns that the greedy search biases incorporated by many standard rule learning algorithms will miss. In this paper, we describe and evaluate several variations of a new genetic learning algorithm (GLOWER) on a variety of data sets. The design of GLOWER has been motivated by financial prediction problems, but incorporates successful ideas from tree induction and rule learning. We examine the performance of several GLOWER variants on two UCI data sets as well as on a standard financial prediction problem (S&P500 stock returns), using the results to identify one of the better variants for further comparisons. We introduce a new (to KDD) financial prediction problem (predicting positive and negative earnings surprises), and experiment with GLOWER, contrasting it with tree- and rule-induction approaches. Our results are encouraging, showing that GLOWER has the ability to uncover effective patterns for difficult problems that have weak structure and significant nonlinearities.

data mining knowledge discovery machine learning genetic algorithms financial prediction rule learning investment decision making systematic trading