Automatically Identifying Predictor Variables for Stock Return Prediction

Real-world financial systems are often nonlinear, do not follow any regular probability distribution, and comprise a large amount of financial variables. Not surprisingly, it is hard to know which variables are relevant to the prediction of the stock return based on data collected from such a system. In this chapter, we address this problem by developing a technique consisting of a top-down part using an artificial Higher Order Neural Network (HONN) model and a bottom-up part based on a Bayesian Network (BN) model to automatically identify predictor variables for the stock return prediction from a large financial variable set. Our study provides an operational guidance for using HONN and BN in selecting predictor variables from a large amount of financial variables to support the prediction of the stock return, including the prediction of future stock return value and future stock return movement trends.