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Using boosting for automated planning and trading systems

Creamer, German

The problem: Much of finance theory is based on the efficient market hypothesis. According to this hypothesis, the prices of financial assets, such as stocks, incorporate all information that may affect their future performance. However, the translation of publicly available information into predictions of future performance is far from trivial. Making such predictions is the livelihood of stock traders, market analysts, and the like. Clearly, the efficient market hypothesis is only an approximation which ignores the cost of producing accurate predictions. Markets are becoming more efficient and more accessible because of the use of ever faster methods for communicating and analyzing financial data. Algorithms developed in machine learning can be used to automate parts of this translation process. In other words, we can now use machine learning algorithms to analyze vast amounts of information and compile them to predict the performance of companies, stocks, or even market analysts. In financial terms, we would say that such algorithms discover inefficiencies in the current market. These discoveries can be used to make a profit and, in turn, reduce the market inefficiencies or support strategic planning processes. Relevance: Currently, the major stock exchanges such as NYSE and NASDAQ are transforming their markets into electronic financial markets. Players in these markets must process large amounts of information and make instantaneous investment decisions. Machine learning techniques help investors and corporations recognize new business opportunities or potential corporate problems in these markets. With time, these techniques help the financial market become better regulated and more stable. Also, corporations could save significant amount of resources if they can automate certain corporate finance functions such as planning and trading. Results: This dissertation offers a novel approach to using boosting as a predictive and interpretative tool for problems in finance. Even more, we demonstrate how boosting can support the automation of strategic planning and trading functions. Many of the recent bankruptcy scandals in publicly held US companies such as Enron and WorldCom are inextricably linked to the conflict of interest between shareholders (principals) and managers (agents). We evaluate this conflict in the case of Latin American and US companies. In the first part of this dissertation, we use Adaboost to analyze the impact of corporate governance variables on performance. In this respect, we present an algorithm that calculates alternating decision trees (ADTs), ranks variables according to their level of importance, and generates representative ADTs. We develop a board Balanced Scorecard (BSC) based on these representative ADTs which is part of the process to automate the planning functions. In the second part of this dissertation we present three main algorithms to improve forecasting and automated trading. First, we introduce a link mining algorithm using a mixture of economic and social network indicators to forecast earnings surprises, and cumulative abnormal return. Second, we propose a trading algorithm for short-term technical trading. The algorithm was tested in the context of the Penn-Lehman Automated Trading Project (PLAT) competition using the Microsoft stock. The algorithm was profitable during the competition. Third, we present a multi-stock automated trading system that includes a machine learning algorithm that makes the prediction, a weighting algorithm that combines the experts, and a risk management layer that selects only the strongest prediction and avoids trading when there is a history of negative performance. This algorithm was tested with 100 randomly selected S&P 500 stocks. We find that even an efficient learning algorithm, such as boosting, still requires powerful control mechanisms in order to reduce unnecessary and unprofitable trades that increase transaction costs.

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Academic Units
Computer Science
Publisher
Department of Computer Science, Columbia University
Series
Columbia University Computer Science Technical Reports, CUCS-032-07
Published Here
April 27, 2011
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