Stock Picking via Nonsymmetrically Pruned Binary Decision Trees
AbstractStock picking is the field of financial analysis that is of particular interest for many professional investors and researchers. In this study stock picking is implemented via binary classification trees. Optimal tree size is believed to be the crucial factor in forecasting performance of the trees. While there exists a standard method of tree pruning, which is based on the cost-complexity tradeoff and used in the majority of studies employing binary decision trees, this paper introduces a novel methodology of nonsymmetric tree pruning called Best Node Strategy (BNS). An important property of BNS is proven that provides an easy way to implement the search of the optimal tree size in practice. BNS is compared with the traditional pruning approach by composing two recursive portfolios out of XETRA DAX stocks. Performance forecasts for each of the stocks are provided by constructed decision trees. It is shown that BNS clearly outperforms the traditional approach according to the backtesting results and the Diebold-Mariano test for statistical significance of the performance difference between two forecasting methods.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2008-035.
Length: 36 pages
Date of creation: May 2008
Date of revision:
decision tree; stock picking; pruning; earnings forecasting; data mining;
Find related papers by JEL classification:
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-05-31 (All new papers)
- NEP-ECM-2008-05-31 (Econometrics)
- NEP-FOR-2008-05-31 (Forecasting)
- NEP-ORE-2008-05-31 (Operations Research)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Balvers, Ronald J & Cosimano, Thomas F & McDonald, Bill, 1990. " Predicting Stock Returns in an Efficient Market," Journal of Finance, American Finance Association, vol. 45(4), pages 1109-28, September.
- Diebold, Francis X & Mariano, Roberto S, 2002.
"Comparing Predictive Accuracy,"
Journal of Business & Economic Statistics,
American Statistical Association, vol. 20(1), pages 134-44, January.
- Kenneth D. West & Whitney K. Newey, 1995.
"Automatic Lag Selection in Covariance Matrix Estimation,"
NBER Technical Working Papers
0144, National Bureau of Economic Research, Inc.
- Newey, Whitney K & West, Kenneth D, 1994. "Automatic Lag Selection in Covariance Matrix Estimation," Review of Economic Studies, Wiley Blackwell, vol. 61(4), pages 631-53, October.
- Hartzmark, Michael L, 1991. "Luck versus Forecast Ability: Determinants of Trader Performance in Futures Markets," The Journal of Business, University of Chicago Press, vol. 64(1), pages 49-74, January.
- Campbell, John Y & Hamao, Yasushi, 1992.
" Predictable Stock Returns in the United States and Japan: A Study of Long-Term Capital Market Integration,"
Journal of Finance,
American Finance Association, vol. 47(1), pages 43-69, March.
- John Y. Campbell & Yasushi Hamao, 1989. "Predictable Stock Returns in the United States and Japan: A Study of Long-Term Capital Market Integration," NBER Working Papers 3191, National Bureau of Economic Research, Inc.
- Hamao, Yasushi & Campbell, John, 1992. "Predictable Stock Returns in the United States and Japan: A Study of Long-Term Capital Market Integration," Scholarly Articles 3207694, Harvard University Department of Economics.
- Kar Yan Tam & Melody Y. Kiang, 1992. "Managerial Applications of Neural Networks: The Case of Bank Failure Predictions," Management Science, INFORMS, vol. 38(7), pages 926-947, July.
- Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
- Neftci, Salih N, 1991. "Naive Trading Rules in Financial Markets and Wiener-Kolmogorov Prediction Theory: A Study of "Technical Analysis."," The Journal of Business, University of Chicago Press, vol. 64(4), pages 549-71, October.
- Chen, Nai-Fu, 1991. " Financial Investment Opportunities and the Macroeconomy," Journal of Finance, American Finance Association, vol. 46(2), pages 529-54, June.
- Keim, Donald B. & Stambaugh, Robert F., 1986.
"Predicting returns in the stock and bond markets,"
Journal of Financial Economics,
Elsevier, vol. 17(2), pages 357-390, December.
- Donald B. Keim & Robert F. Stambaugh, . "Predicting Returns in the Stock and Bond Markets," Rodney L. White Center for Financial Research Working Papers 15-85, Wharton School Rodney L. White Center for Financial Research.
- Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-617, December.
- Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
- Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (RDC-Team).
If references are entirely missing, you can add them using this form.